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Question:
Do
you agree that companies with plenty of cash make
good buys?
Kim
Gorse
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Answer:
Dear
Kim,
Yes...in
general I agree. A large cash position means a company
has plenty of money to handle down cycles, to pay
interest on any outstanding debt (this is especially
critical when its loan rates escalate), to weather
temporarily being out-of-favor with its target audience
or with Wall Street), to pay (or even increase) dividends
-- keeping shareholders happy -- and to buy back its
own shares.
And,
when interest rates are relatively high, as they are
now, that means a company's earnings on its savings
can be substantial.
According
to Standard & Poor's, interest generated by cash held
by industrial companies in the S&P 500 Index is expected
to be up 64% this year. That could mean 3.6% more
in company earnings.
Potential
pitfalls of cash
However,
it's also important that a company not simply sit
on its pile of cash. At a certain point, a thriving
company needs to hire new people, expand its research
and development efforts, market and advertise its
new products or services, replace outdated machinery
and revamp or rebuild aging factories or other physical
facilities.
Two
additional points of concern -- that the company will
make a poor acquisition decision simply because the
cash is sitting there. And, of course, cash-rich companies
often invite takeovers.
Industries
with cash
Industries
that typically have had large cash positions in the
past several years have been: drugs/pharmaceuticals,
oil and gas, health care and tobacco. However, those
industries continually change. Here's S&P's current
list for the industrial segment of the market. It
does not include the financial, utilities and transportation
groups, which generally have strong cash position,
with the current exception of some airline companies.
| INDUSTRY |
CASH
% OF MARKET VALUE |
| Consumer
discretionary |
5.83% |
| Consumer
staples |
3.75 |
| Energy |
6.78 |
| Health
care |
10.19 |
| Industrials |
3.19 |
| Information
technology |
12.64 |
| Materials |
6.01 |
| Telecommunications |
7.42
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As
you know, we cannot recommend specific stocks for
you to buy; however, you can study the cash positions
for any one of the 1,700 companies followed by independent
analysts who write for the Value Line Investment
Survey (www.valueline.com).
Good
luck!
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