Novice Investing - Cash is King

Date: Sunday 20th 2008f July 2008 12:41:17 PM

Cash is King - 07/14/2005

By: Novice Investing Staff

Why cash?

As you probably might have noticed, we prefer investing in companies that have significant positive net cash; that is cash on hand that is significantly larger than its long-term debt. On the other hand, companies with negative net cash, have more long term debt than cash on its balance sheet. Most of our analysis in the portfolio section, are companies with positive net cash. Please click here to see our past stock analysis.

When downturn occurs, companies with negative net cash are more affected as they need to find a way to pay interest on its long term debt. To service debt, they need to use cash from operation or if they are not profitable, they need to sell their assets. Remember that we are talking about a downturn here. Incurring losses is not uncommon in certain industries. When highly leveraged companies sell their assets, they do it at the worst possible times! In a downturn, everybody is more cautious and assets are valued lower than during boom times. Everyone is trying to conserve cash. Meantime, companies with positive net cash have more money to spend than companies with negative net cash. So, guess who would buy the assets on the cheap? Yup. Companies with significant positive net cash.

Other than withstanding economic downturn, companies with significant positive net cash are also able to buy back shares and distribute dividend to its shareholders. In a word, positive net cash is awesome!

So, what now? Companies with positive net cash are not necessarily good investments. But, it is the first step towards finding a profitable investment. To refine our search, we normally look at companies that are profitable as well, preferably with low Price Earning Ratio. This is to make sure that the cash can continue growing. One such company is Magna International Inc. (ticker: MGA). It is one of our portfolio pick back in April 15th 2005. It has $7/share of net cash and it is profitable earning more than $7/share every year.

The table below offers cash-rich candidates that might be future investments.

Company	Recent Trade (07/11/05)	Net Cash per Share	Expected EPS
Sharper Image (SHRP)	$ 12.89	$ 3.95	($ 0.01)
King Pharmaceuticals (KG)	$ 10.81	$ 0.28	$ 0.93
Creative Technology Ltd (CREAF)	$ 6.40	$ 2.12	$ 0.00
ATI Technologies Inc. (ATYT)	$ 12.93	$ 2.07	$ 0.66
Sigmatel Inc. (SGTL)	$ 16.59	$ 4.20	$ 1.67
PetroKazakhstan Inc. (PKZ)	$ 37.80	$ 0.85	$ 6.16

Conclusion

Everybody needs cash to survive, including publicly traded companies. Cash-rich corporation can afford to lose money during business downturn. For example, Sharper Image (SHRP) is expected to incur a loss of a penny a share. Will the loss causes SHRP to sell off its assets to cover cost? Not likely. It has nearly $4/share of cash in the bank. It can survive for quite some time. Of course, it cannot incur losses forever. Our investing objective is to find out what might turn the business around. Once the business turns around, we believe Sharper Image stocks will be much higher than today.

END

Related articles for Novice Investors:

Why Invest Now (last updated 05/31/2005)

The Value of One Dollar (last updated 05/04/2005)

Evaluating Risk in Stocks (last updated 11/10/2004)

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