Investing in Companies with Cash

May 31, 2010 Investing, Investing Tips, Investing/Trading No Comments

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The economic recovery has been slow and there are still all sort of economic warning signs. Thus many companies have been accumulating cash reserves to protect against the dreaded “W” shaped recovery. That is, folks have been concerned that the economy would take another dive before resuming economic growth. What we see now is that many companies are sitting on piles of cash which they will soon be putting to use. We can expect to see dividend increases, increased investing in R&D, repurchase of shares, and acquisitions of competitors. The business of picking new winners may become a focus on old winners, the large cap companies that control so much of the American marketplace. Investing in companies with cash may be the way to go.

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Investing in companies with cash brings us back to some recent topics such as investing in beer and investing in oil. Well managed companies with strong products or companies that are in unassailable positions in high cost of entry businesses, such as oil exploration, drilling, and refining, have the ability to accumulate lots of cash. These companies are typically the old stalwarts that grow slowly but don’t disappear in a flash during an economic downturn. A surprise increase in dividends is always welcome and buying back shares often will increase the price of remaining shares. Both of these actions can profit shareholders. What the investor will want to watch out for is acquisitions. Sometimes buying a competitor works and sometimes it just serves to take on the problems of the other company. A real concern is when the cash rich company decides to go out and buy a company in a field of business outside of the buyer’s field of expertise. Remember Xerox buying an insurance company in the late 1970’s just before a major hurricane arrived?

More than just a little fundamental analysis will be appropriate when investing in companies with cash. We will use Xerox as an example again. Xerox invented copiers and became a very wealthy company. However, as they were using their cash to buy insurance companies, etc., Asian companies were perfecting the copier and by the end of the 1970’s could manufacture, deliver to the USA, and sell copiers for less than Xerox’s cost of production. It took the company a change in management, significant downsizing of its bloated and bureaucratic front office and renewed investment in R&D in order to reclaim its position at the top of the heap of copier makers. This is where it may be wise to be wary when investing in companies with cash. A fat dividend check is a nice thing to have and a growth in share price because of buybacks would be nice too. However, it is the ability of companies to create products, find new markets, devise efficiencies that increase profits, and the like that, in the end, make cash rich companies attractive. So, look for companies with lots of cash but look at what they intend to do with that cash.