Cash Is King

Today is a huge day for earnings. Six Dow components report today. Thanks to yesterday’s big move, the market is again close to five-year highs.
The government reported that consumer inflation rose by 0.4% last month. The core rate, which excludes food and energy prices, rose 0.3%. Although bonds rallied on Monday and Tuesday, yields are headed higher this morning.
I’ve been looking at a lot of balance sheets lately, and I’m surprised at the level of cash that many corporations are holding. Microsoft (MSFT), for example, has $35 billion in the bank. Think about that. Their bank account is larger than most banks. In fact, by itself, Microsoft’s bank account would be the 70th largest stock in the S&P 500. ExxonMobil (XOM) isn’t far behind with $29 billion in cash, and Pfizer (PFE) has $22 billion.
What is everyone waiting for? Perhaps Microsoft will pay another special dividend. I think it’s interesting that a software company is one of the largest lenders in the country, and it isn’t even part of the Federal Reserve System.
On my first job as a broker, I remember how we were trained in our “pitches” to say things like “best of all, this company has a mountain of cash” or “don’t forget, cash is king.” I didn’t know what the hell I was talking about. Holding a lot of cash isn’t in and of itself a great thing. Cash doesn’t do much besides earn interest, and I don’t need to buy a stock to do that. The whole idea of investing is exchanging cash for assets that are (hopefully) more productive.
While I’d prefer to own a company that has little debt and a nice wad of cash, it’s not imperative. It can even be a slight negative. This is what’s known as the Bladder Theory of corporate finance. The odds that you’ll do something intelligent with your cash stash is inversely proportional to the amount of cash you have. Given the past few years, I don’t think the Bladder Theory is just a theory anymore. Google (GOOG) is sitting on $8 billion. That’s $27.13 a share. We all know they’re great at technology, but now we have to see how good they are at investing. I hope they’re better at investing than they are at PR. I know they’re going to buy somebody soon, but dear lord, I’m afraid to guess.
The reason why I like to see how much cash a company has is that it can distort how much a stock is worth. Let’s look at Microsoft again. The company is going for $27.13 a share, which is about 17.7 times next year’s earnings of $1.53 a share (their fiscal year ends in June).
But! The company has no debt and $3.35 a share in cash. So let’s remove the cash and look at the valuation. Minus the bank account, Microsoft is trading at $23.78 a share. Let’s estimate that the cash will generate earnings of 15 cents a share (that’s about 4.5%). This means that Microsoft’s business will generate earnings of $1.38 a share. So Microsoft’s business operations are really going for 17.2 times earnings. That’s a slightly different picture.
While Microsoft is trading at 8.1 times cash, Dell is going for just 7.3 times its cash. Other cash-rich stocks on our Buy List include Fair Isaac at 8.3, Golden West at 11.8, Harley-Davidson at 13.4, Medtronic at 12.1, Respironics at 10.4 and UnitedHealth at 11.2.

Posted by on April 19th, 2006 at 9:58 am


The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.