By Dave Goodboy
My favorite thing about investing is that you never stop learning. No matter how much knowledge you think you have, there is always something new that can open up an entirely different perspective on a topic. Recently, I learned an interesting and lucrative piece of information from StreetAuthority Co-Founder Paul Tracy's "Dividend Vault" investing strategy.
The Dividend Vault strategy has its roots in the little-known fact that U.S. companies are sitting on record amounts of cash. According to form Z.1 on the Federal Reserve's website, U.S. companies have about $1.7 trillion of cash stockpiled today. To put this number in perspective, it totals more than the gross domestic product of 180 nations. It's enough money to write every retiree in the country a check for $42,500.
The reason for corporate America's cash hoarding is simple. Back in the financial crisis of 2007 and 2008, banks cut off credit lines and basically ceased to lend to any company, regardless of how strong its past credit history had been. Cash is the lifeblood of corporate America, so the fearful companies reacted by building large cash reserves to self-fund future needs.
Fortunately, the financial system has bounced back, with corporate credit slowly returning to pre-crisis levels. Now, these cash-rich companies are stuck with a dilemma on how to dispose of all this extra cash.
The most sensible answer: Giving it back to shareholders in the form of dividends.
And this has already started to happen. Last year, for example, S&P 500 companies paid a record of more than $281 billion in dividends, up 17% from 2011. And as Paul says, "the next 10 years will likely be known as the 'Dividend Decade,' with all of the market's total returns being credited to dividends."
Knowing this, my priority has changed to focus on stable, cash-rich stocks that pay dividends. So I developed a simple screening method to find these companies.
I designed the screen to search only for large-cap stocks with a one-year operating margin of greater than 15% and an annual earnings growth rate greater than 10%.
To weed out only the firms with strong cash reserves, the screener eliminated all stocks with quick and current ratios of less than 2. As a quick explanation, the current ratio (current assets divided by current liabilities) measures how much liquidity a company has. A reading of at least 1.5 means the company can meet its operating obligations. The quick ratio (current assets minus inventories divided by current liabilities) measures the company's ability to meet its short-term operating needs. This means a quick ratio of more than 1 let's us know the company has cash to pay its bills and continue operating.
Here are two companies that passed the above screen and could be potentially the ultimate Dividend Vault stocks:
1. Oracle Corp. (NASDAQ: ORCL)
This technology software and hardware company boasts a current and quick ratio of about 2.6. It has an operating profit margin of more than 36% and an earnings annual growth rate of about 18%. A market cap of nearly $150 billion combined with total current assets of $41 billion ensures Oracle's stability.
During the last four quarters, the company returned $10.2 billion of its operating cash flow to shareholders by repurchasing almost 350 million shares. It also used some of this extra cash to ramp up its dividend payments. The latest quarterly dividend was 18 cents per share. This is more than triple the 5-cent quarterly dividend paid just two years ago.
The current yield is just 0.7%, but it's critical to remember that Oracle is among the very few firms in the software sector to pay a dividend.
Technically speaking, the stock price has been uptrending since Nov. 13, 2012, hitting resistance in the $36 area. The price has dropped back to the 50-day simple moving average in the $34 range. This pullback creates a solid value "buy" zone. Buying in this range with stops at $33 and a $44, 12-month target makes technical sense for this cash-rich company.
2. Chemical & Mining Co. of Chile (NYSE: SQM)
This cash-rich company produces and sells fertilizers and specialty chemicals in Chile and internationally. It's also the world's largest lithium producer. I've talked about the high demand for lithium batteries in this article.
The company has an earnings growth rate of nearly 43%, an operating profit margin of almost 36% and a current ratio of more than 3. Combine that with a quick ratio of 2, a market cap of nearly $16 billion and an annual dividend yield of 2.8% with steady payments since 2001, and we have a powerful fundamental case for this company.
Technically, this stock has been punished. The price has plunged from a high of more than $64 in September 2012 to a recent low in the $54 range. It's trading below the 50-day and 200-day simple moving average, eliminating it from the value "buy" zone paradigm. However, there is solid support at $54. A daily close breakout above the 50-day and 200-day simple moving averages in the $57 range and a $64,18-month target makes technical sense for this cash-rich stock.
Risks to Consider: High cash stockpiles do not guarantee the success of a company. While having plenty of cash is generally a positive, there are many factors that can negate its value. Always use stops and position size properly.
Right now, Oracle is a perfect "buy" candidate. I would wait for Chemical & Mining Co. to show signs of upward momentum before it becomes a good buy.