Cash Flush Stocks

By Sham Gad | May 19, 2010 AAA

An interesting article in the most recent issue of Barron's identified a great list of companies with cash rich balance sheets. It's a must read and the list of 20 names is certainly worth a spending some time on. The value of cash to a company never looks obvious until a business needs it most. It's only then that one realizes why the balance sheet should always come before the income statement in valuing a business.

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Don't Overpay for Cash
However, just because a company is cash rich doesn't mean it's a good investment. In fact, companies flush with cash can often have rich share prices. Google (Nasdaq:GOOG) is one such name. It's an excellent business with a dominant position in the tech space. Google is now a $160 billion company with nearly $30 billion in cash and short term investments. But shares currently fetch 23 times earnings. In addition, the company's free cash flow figure of $8.5 billion in 2009 values the company at 20 times free cash flow. Compare that with Microsoft (Nasdaq:MSFT), a $250 billion company churning out over $16 billion in free cash flow last year.

Cheap Cash Plays
Yet just as the market has enriched the share price of some cash rich stocks, it has also left some potential bargains in the wake. Forest Labs (NYSE:FRX) is an $8 billion company with over $3 billion in cash and no debt. Shares trade for under 9 times next years earnings. And the company has generated over $1 billion in free cash flow a year over the past two years, or 8 times the value of the company. On an enterprise value basis, Forest Labs shares trade for less than 5 times free cash flow.

Another interesting name on the list was health insurance provider Humana (NYSE:HUM). Humana appears on both Barron's categories of cash rich stocks: businesses with a high cash to asset ratio and greatest free cash flow to market cap yield. All insurance companies are required to hold a required level of statutory cash, so you will find most well known insurance companies to have a net cash position. Nevertheless, Humana has over $6.5 billion in net cash against a $8 billion market cap. The shares trade for under 9 times next year's earnings and generated over $1.2 billion in free cash flow in 2009.

Counting Cash
Cash always looks boring when it builds up and just sits there. Sure there is legitimate concern that cash rich companies can make poor investment decisions with the cash. But identify quality companies with loads of cash, and the upside optionality looks great. (For related reading, see Value Investing Using The Enterprise Multiple.)

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