7 Stocks That Are Swimming in Cash

And today, many (The Economist, for example) are saying it loudly.

According to The Wall Street Journal, 64,000 companies bit
the dust and filed for bankruptcy in 2008. And, terrifyingly still,
credit markets are bracing for significant increases in corporate
default rates in 2009.

For those companies that survived this first wave, the really
bad news is that debt will still require repayment, employees will
still want their paychecks, and electricity bills will still fall on
their doorstep every month. Companies need cash -- and the ones holding a lot of greenbacks should do quite well.

I've found seven companies that have tons of cash, but it doesn't really matter. Let me explain why.

Cash helps, no doubt
I think we can all
agree that an adequate amount of cash on the balance sheet is an
excellent defense for a company facing complete, financial destruction.
Without cash on hand, not even the most iconic companies -- think Kraft (NYSE: KFT) or FedEx (NYSE: FDX) -- could survive. Bear Stearns went under not because of insolvency, but because it had no liquidity.

But there's a bigger problem.

You may be looking at the cash line on a company's balance sheet
with the belief that companies with lots of cash will be the companies
that can avoid bankruptcy, and therefore be properly positioned to
succeed in the future. You might be tempted to buy shares of these
companies.

Not so fast.

I agree -- to some extent. These companies probably won't go
bankrupt (in the near term, at least), but it has nothing to do with
how well the company can or will do in the future. That train of
thought will steer investors into a classic mistake.

Show me the money!
I've selected seven
companies with market caps larger than $500 million and cash in excess
of 20% of that market cap (which is a lot of cash!) to illustrate a
simple point:

Source: Capital IQ, a division of Standard & Poor's.

These are relatively some of the "richest" companies in the world.
But that fact alone doesn't have any bearing on whether they make for
good investments.

Market beaters? Maybe.
These companies could
be burning through cash faster than a teenager with your gold card --
or they could be tossing lots of money into that expensive new pet
project that may or may not work.

You just don't know with these figures alone. The financial picture remains incomplete.

A tale of two opposites
Take Apple and
Sprint Nextel, for example. Both have lots of cash. But Apple has more
than $25 billion in cash, no debt, hauled billions in free cash flow in
the past 12 months, and pushes returns on invested capital at rates in
the ballpark of 20%.

Sprint, on the other hand, has $3.7 billion in cash, carries a
whopping $22 billion in debt, fails to deliver nearly as much cash flow
per revenue dollar, and fails to push positive return rates on invested
capital. Most of what cash is made just goes back to debt holders.

Suffice it to say that these are two different companies in two remarkably different places.

I'm not saying that Apple is a much better investment than Sprint
(OK, it is); I'm simply trying to illustrate why looking at cash
figures can be misleading.

The same is true when comparing a company like Activision with
Alcatel-Lucent. Both have lots of cash, but gee-whiz Alcatel has some
serious work to do if it wants to reinspire shareholders.

Cash is just one piece of the puzzle
Instead
of simply highlighting companies with huge bank vaults, ask yourself
whether a given company will be adding to that stockpile in the future
or taking away from it. And most important, identify just what the company intends to do with that cash.

Companies sporting generous coffers can't guarantee that their
products are going to sell in the future or that their industries are
sustainable for the long term.

Cash is necessary -- necessary to avoid bankruptcy in the short term
and to operate properly in the medium term. In fact, we Fools like our
stocks to support healthy cash cushions in the (likely) event of an
emergency. But cash can only get you so far. Companies still need to
have a plan -- a good plan -- for that cash.

The truth is stranger than fiction
There is
another wrinkle you should know about cash and the people who hold it.
According to research confirmed by several different sources, the best
managers of cash tend to be, ironically, the same companies that
regularly redistribute it back to shareholders in the form of dividends.

As the master of your own money, you can probably appreciate how a
dividend-paying company with limited resources must be more disciplined
with its spending, because it knows it'll have to pony up a dividend to
shareholders on a regular basis. Over the long run, these institutions
generally become better stewards of capital.

The difference isn't marginal, either. Research has shown that from
1972 to 2006, S&P 500 dividend-paying stocks actually performed
significantly better than their non-paying peers -- by a sizable margin
of six percentage points per year! That outperformance can be at least
partly explained by the burden (a blessing for shareholders) of having
to pay a dividend regularly.

Copyright © 2009 Universal Press Syndicate.