Got Cash?

| September 28, 2010 | 0 Comments

Americans’ collective wallet got a bit lighter last quarter.

According to the Federal Reserve, household net worth dropped $1.5 trillion in the second quarter.  Clearly, this is another blow to consumers struggling to repair their balance sheets.

I’m sure you’ll agree it’s a tough environment for consumers.  How are they supposed to be optimistic when their net worth is still nearly 20% off its 2007 peak?

But that’s just part of the story.

Individuals may be strapped for cash… But corporations are flush with cash.

In fact, the Federal Reserve said corporate cash is at near record levels. Right now they have an incredible $1.84 trillion in the bank.  And non-financial companies in the S&P 500 have $837 billion of it…

This cash is just idling on the sidelines.  And it’s been sitting there for a while.  Companies have been sitting on their horde of cash for months, or in some cases, years.

I was hoping this cash would pump up the economy as the recovery took hold.  But it hasn’t happened.  Even as the economy has strengthened, companies have been unwilling to part with their cash.

There are plenty of reasons why they haven’t… But the two cited most often are lack of opportunities and fear of another downturn.

But here’s the kicker…

I think companies are finally going to put their cash to good use.  And it makes a strong case for buying companies with high cash balances.  I’ll tell you one company I’m bullish on in a minute…

Here’s the deal…

In the last year, 96 S&P 500 companies managed to increase earnings per share while revenues fell.  There’s only one way to pull off this feat… cutting costs.

Clearly, stocks are benefiting from cost cutting.

Now corporate America is lean and mean.  There’s no more “fat to cut”. Companies won’t be able to boost earning by cutting costs going forward.

What I’m leading up to is this… It’s going to be hard for companies to keep up with their recent earnings growth rates.

Unless the economy picks up steam, many companies will see earnings growth fall short of expectations.  And judging by recent economic data, the recovery is going to be painfully slow.

But companies sitting on huge stockpiles of cash have a few other options.

They can reward shareholders by increasing dividends, starting share buybacks, and making acquisitions.  If done properly, share buybacks and acquisitions can be a big boost to earnings per share.

That’s why I think companies with big cash balances will outperform over the next couple of quarters.  They have the ability to deliver value to the shareholder.

One company I like is sitting on $18 billion in cash.  And they’re already starting to spend it to boost earnings and shareholder value.

Intel (INTC) is a company that doesn’t need much of an introduction. They’re the world’s largest semiconductor manufacturer.

They recently purchased computer and software security company McAfee (MFE) for $7.68 billion.  This deal will provide a long term boost to their top and bottom line growth.

McAfee had over $2 billion in revenue in 2009.  And it has “enjoyed double-digit, year-over-year growth and nearly 80 percent gross margins last year”.

The acquisition isn’t expected to immediately boost Intel’s earnings.  But in the long run, their new business has much better growth prospects than the $8 billion in cash sitting on their balance sheet.

Remember, Intel could be managing expectations with their prediction the acquisition will be dilutive to earnings.  By setting the bar low, any boost the acquisition provides to earnings will be seen as a huge positive.

And to top it off, they’re currently in the midst of a $25 billion stock repurchase plan.  And they already increased their dividend to $0.63 earlier this year.  It’s now yielding 3.2%.

Simply stated, Intel is doing all the right things to increase shareholder value.  And they can do these things because of their cash position.

Here’s the bottom line… Big companies will find it hard to cut costs and boost earnings per share.  Those with cash have a huge advantage.  So take a closer look at the companies sitting on mountains of cash.  They’re the best positioned to deliver shareholder value in a slow growth recovery.

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Category: Stocks

About the Author ()

Corey Williams is the editor of Sector ETF Trader, an investment advisory service focused on profiting from ETFs and the economic cycle. Under Corey’s leadership, the Sector ETF Trader has become one of the most popular and successful ETF advisories around. In addition to his groundbreaking service, Corey is the lead contributor to ETF Trading Research, where he shares his insights about ETFs and financial markets on a daily basis. He’s also a regular contributor to the Dynamic Wealth Report and the editor of one the hottest option trading services around – Elite Option Trader.

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