Should You Buy the Dow's Cash Kings?
Now more than ever, investors are focusing squarely on one thing: cash. They want to know how much cash companies have in their corporate coffers, and what those companies intend to do with it. They want more of it back in their pockets through dividends and share buybacks. And they want to make sure that the stocks they invest in are backed by cash-generating businesses that will keep the money rolling in for years to come.
I'll take a look at some of the Dow Jones Industrial Average's (INDEX: ^DJI) most cash-rich companies and their prospects. But first, let's get some background as to how cash became king in investors' eyes once again.
How cash got so important
As often happens, you don't know what you have until it's gone. For companies, the cash crunch that accompanied the financial crisis in 2008 created a huge separation between companies that had cash and companies that didn't. Cash-strapped companies were faced with a nearly complete inability to get liquidity as credit markets locked up, leading to spiking financing costs and the need for government intervention to get funds flowing again. Meanwhile, cash-rich companies got through the crisis much more comfortably and were in a position to evaluate unique strategic opportunities that came up.
Now, conditions have improved greatly. Companies have turned to the credit markets in mass, issuing bonds to take advantage of record-low interest rates and bolstering their coffers for whenever the next cash crunch might hit. And even though corporate America overall is still being fairly stingy in spending its cash, a number of companies have made moves to loosen the purse strings and return at least some of their capital to investors.
Who's got it?
Leaving aside financial institutions, whose very business model necessitates having huge amounts of cash on hand offset by equally immense debt, the Dow's big technology companies appear at the top of the cash list. Microsoft (NAS: MSFT) has more than $50 billion in cash and short-term investments, while Cisco (NAS: CSCO) weighs in with almost $47 billion.
In some analysts' eyes, that's a big problem. As Fool contributor Travis Hoium points out, when companies get too much money, they sometimes do stupid things with it. Cisco's $590 million fling with Flip Video maker Pure Digital Tech turned out to be a money-losing proposition, as the company recently chose to write down more than half of its purchase price. Fool tech analyst Eric Bleeker thinks that Cisco's $5 billion buy of NDS Group may prove equally ill-suited to the company's overall strategy. And while the jury is still out on Microsoft's $8.5 billion buyout of Skype, few were excited about the purchase at the time.
Who's making it?
But a critical follow-up question goes beyond what companies have cash to look at which companies are making more cash to replenish their coffers. When you look at free cash flow, Microsoft again rises to the top of the list excluding financials, but Cisco sinks down into the pack. Instead, oil giant ExxonMobil (NYS: XOM) and drugmaker Pfizer (NYS: PFE) rise to the occasion, with $24.4 billion and $18.6 billion in free cash flow, respectively, over the past 12 months.
All four of these companies have something in common: They face a threat to their future cash-making ability. On the tech side, for Microsoft, some analysts fear that its long dominance in operating-system and office software will come to an end, taking away its biggest cash cow. Cisco has made some competitive missteps that allowed competitors to gain traction in important niche markets.
But Pfizer and Exxon have similar concerns. Pfizer has to deal with the constant churn of drugs going off patent, forcing it to find replacements to keep the cash coming in. Meanwhile, Exxon thrives with oil above the $100-per-barrel mark, but it knows all too well how volatile the energy markets can be, and depending on windfalls to last more than a year or two into the future can be a risky gamble.
What to look for
Ultimately, what determines the value of an investment is how much cash it can generate. Looking at cash-rich companies that look to stay profitable well into the future is definitely a smart move, especially if you can pick up shares at reasonable valuations.
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At the time this article was published Fool contributorDan Caplingerdoesn't own shares of the companies mentioned. You can follow him onTwitter. The Motley Fool owns shares of Microsoft and Cisco Systems.Motley Fool newsletter serviceshave recommended buying shares of ExxonMobil, Microsoft, and Pfizer, as well as creating a bull call spread position in Microsoft. Try any of our Foolish newsletter servicesfree for 30 days. We Fools don't all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Fool has adisclosure policy.
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