John Reese is founder and CEO of Validea.com and Validea Capital Management, and portfolio manager for the Omega American & International Consensus funds. Globe Investor has a distribution agreement with Validea, a premium Canadian stock screen service. Try it.
Companies that have big stockpiles of cash got a tongue-lashing this summer from Bank of Canada Governor Mark Carney, who says such firms are using "excessive" caution that is hindering economic growth.
But while these cash-rich firms are a target of Mr. Carney's ire, such companies also attract attention from highly successful investors for more positive reasons. Companies with lots of cash can increase their dividends, buy back their own shares or put money back into their business to help it grow.
Top fund managers such as Bruce Berkowitz and David Herro pay close attention to a company's free cash flow yield. And nearly all of the investing greats upon whom I base my Guru Strategies look at cash levels in one way or another.
Right now, plenty of firms are awash with cash. At the end of the first quarter of this year, non-financial companies in the S&P 500 had more than $1.2-trillion (U.S.) in cash and marketable securities on their balance sheets, up about 50 per cent since 2008, according to FactSet Research. In Canada, non-financial firms held more than half a trillion of cash at the end of the first quarter, up 43 per cent since early 2009, according to Statistics Canada.
Before you go loading up on stocks of cash-rich companies, a warning: Just looking at cash levels can be misleading if a company has ramped up its debt along with its cash level. Many companies are likely doing that these days as they take advantage of near-zero interest rates.
When analyzing a company, I prefer to look at the net cash-to-price ratio, a measure that mutual fund great Peter Lynch liked. Mr. Lynch defined net cash as cash and marketable securities minus long-term debt. The investment model I base on his writings gives stocks bonus points if their net cash-to-price ratios are above 30 per cent – a very tough target.
Of course, you should never pick stocks using just one variable. So recently, I searched for stocks that have the highest net cash-to-price ratios in both the U.S. and Canadian markets, and which also get approval from one or more of my guru-inspired models. Stocks like these could get a big boost as they put their cash stockpiles to use.
Humana Inc.
This Kentucky-based health insurer has a net cash-to-price ratio of 65.2 per cent, part of why it gets a very strong score from my Lynch-based model. The approach considers Humana a "fast-grower" – Mr. Lynch's favourite type of investment – thanks to its rapid 22.8 per cent growth rate in earnings per share.
C&C Energia Ltd.
Based in Calgary, C&C's main operation is done through a subsidiary that is involved in the acquisition, development, and production of oil resources in Colombia. Investors should proceed with caution: C&C's shares trade at rather low volume, so this small cap company is subject to higher volatility than bigger firms.
Still, the model I base on the writings of hedge fund guru Joel Greenblatt thinks it's worth a look. Mr. Greenblatt's approach is a remarkably simple one that looks at just two variables: earnings yield and return on capital. My Greenblatt-inspired model likes C&C's 33.6 per cent earnings yield and 28.1 per cent return on capital, which combine to make the stock the 18th best in the entire Canadian market right now, according to this approach.
Ceradyne Inc.
California-based Ceradyne produces advanced technical ceramic products and components ranging from body armour to oil drilling tools. It has an impressive 47.4 per cent net cash-to-price ratio.
The firm also has a pristine balance sheet, with no long-term debt, a big reason it gets strong interest from the model I base on the writings of Benjamin Graham. Ceradyne also offers good value, trading for 14.5 times three-year average earnings.
Lexmark International, Inc.
Kentucky-based Lexmark sells printing and imaging products and services across the globe. It has long been a strong cash generator, and last year it took a big step in putting its cash to work by initiating a dividend program.
It now offers investors a handsome 5.6 per cent yield, and is still boasting an impressive net cash-to-price ratio of 55.8 per cent. Those two figures are part of why Lexmark gets strong interest from my Lynch-based approach.
John Reese