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Persistent market volatility benefits cash-rich companies like these

In this article, I present the strategy that focuses on cash-rich firms. Ongoing market volatility due to banking industry apprehensions and recession concerns has made companies with solid cash positions more likely to succeed during these turbulent times. The average annual gain of the AAII Cash Rich Firms Screening Model since the beginning of 1998 is 7.2%, compared to 5.6% for the S&P 500 Index over the same period.

Investing in Cash-Rich Firms

A healthy cash position provides vital flexibility and security to a firm. Cash-rich firms should be able to meet their debt obligations easily, reducing the likelihood of a creditor, diluting the position of equity investors or even gaining control of the firm. During an economic downturn, cash allows a cyclical firm to continue its research and development (R&D) efforts, as well as capitalize expansion or improve productivity in anticipation of an economic rebound.

Firms with excess cash positions may also elect to distribute cash to shareholders in the form of dividends. Many firms also choose to use the excess cash to repurchase shares on the open market. It helps to boost the share price in the short term by providing demand for the shares. And with fewer shares outstanding, the same level of net income boosts earnings per share.

Firms with excess cash may also attempt to use the cash strategically to broaden their product lines or diversify into new areas. This can be accomplished either through direct capital investment or outright purchase of another firm.

The high cash position can also be a disadvantage. Cash is generally defined as cash as well as marketable securities that are readily convertible into cash. This includes short-term instruments such as bank deposits and treasury bills. The cash position can reduce profitability if it earns a lower rate of return than other assets in the company. Any corporate investment would be expected to earn more than the money market rate in the long run.

When looking for companies with large cash balances, the important question becomes: Why are they holding on to cash? Often, this points to a firm in a mature industry with some growth potential. The firm may have a reasonable profit margin, but requires little additional capital. The need for a good management team is especially important for such a company.

Cash Level Measurement and Screening

Firms must report their cash holdings quarterly, which is done when they file their quarterly financial statements. Cash and cash equivalents are the most liquid assets on the balance sheet. Dividing the cash by the number of shares outstanding gives us a measure of cash per share. The amount of cash per share relative to the market price per share provides a useful indication of a firm’s cash level.

Screening for firms with a high ratio of cash to stock value represents a reasonable strategy for tracking down cash-rich firms. When performing such a screen, it is important to exclude companies in the financial sector because the nature of their business requires them to hold large cash positions. Utilities are excluded due to their regulated nature and overall low growth potential. Real estate investment trusts (REITs) are also excluded due to their unique organizational structure and non-comparable financial statements.

Filters requiring positive earnings from continuous operations for the preceding 12 months, except for financials, utilities and REITs, are specified as the minimum current profitability requirement. This very simple screen helps to indicate that the passing firms are at least making some money in their ongoing operations. More stringent screens may look for positive free cash flow or positive cash flow from operations.

The next criterion specifies a minimum share price requirement of $5. Without a minimum share price requirement, bankrupt firms can dominate the screen with a share price of a few pennies.

To measure a firm’s financial strength, we first examine the debt-to-equity ratio below the industry norm. It is a popular measure of financial leverage. Debt in this ratio includes only long-term debt, not total debt. Capital refers to all sources of long-term financing – long-term debt and shareholder’s equity. A higher ratio indicates higher risk. However, if current liabilities are high then a low level may not indicate low risk.

To help measure overall levels of liabilities, we also require that debt relative to total assets be below industry norms. The debt-to-net-assets ratio measures the percentage of assets financed by all types of debt. A higher percentage, and greater potential variability of earnings, translates into a greater potential for default. Nevertheless, judicious use of debt can boost return on equity.

Our final conditioning screen looks for a minimum market capitalization (value per share times outstanding shares) of $50 million to help ensure a minimum level of trading liquidity.

Screening for High Gross and Net Cash

Our first screen for high levels of cash compares cash per share to stock price. We are looking for stocks with a cash level of at least 20% of the stock price. If you were to buy a $20 stock with cash representing 20% ​​of the stock value, one could argue that you are only paying $16 for the business.

As important as it is to look at cash, it is equally important to look at the financial obligations of the firm. A high level of cash per share can quickly become diluted when considering the firm’s short-term liabilities and long-term debt. Some companies build up cash reserves to ensure that they can meet required payments on their short-term debt and the current portion of long-term debt.

A useful modification to the ratio of gross cash to per share price is to subtract short-term liabilities from cash to establish the net cash per share figure, which provides a better measure of excess cash on hand. Net cash per share divided by the share price shows how much of this “excess cash” is available on a per share basis.

Our second screen for high levels of cash looks at stocks with a net cash per share level of at least 20% of the stock price. The companies table below lists both net cash per share and net cash as a percentage of stock price. Generally, many firms with a positive ratio of cash to stock price have a negative ratio once short-term liabilities are considered.

Apart from looking at the stable cash position of these firms, it is even more important for a long-term investor to check the actual cash generated by the firm. We do not examine this element in our analysis, but measures such as cash flow or free cash flow can help get a feel for cash generation. Free cash flow is calculated by taking cash flow from operations from the firm’s cash flow statement and subtracting capital expenditures (capex) and dividends. This measure attempts to capture whether the firm is generating enough cash to help fund any necessary internal capex.

trust in management is important

Investigating cash-rich stocks is not an easy process. Initial filters should screen for companies that not only have high levels of cash per share, but also a strong balance sheet, the potential for future earnings growth, and positive free cash flow per share. AAII’s screen highlights companies with a relatively large percentage of net cash on hand. A high net cash level relative to share price does not ensure financial strength or price stability. In selecting the final candidates, much of the analysis depends on your confidence in management’s ability to wisely use and invest any cash holdings.

Stocks That Passed the Cash Rich Firms Screen (Ranked by Cash to Price)


Stocks that meet the criteria for an outlook do not represent a “recommended” or “buy” list. Doing due diligence is important.

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