Given today's spectacularly low interest rates, holding cash is an easy way for a company to depress its returns on equity. But if a firm is struggling, a cash hoard can go a long way toward helping it cope, or in some cases, even survive. With successful companies, the presence of cash opens up opportunities, either for reinvestment in the company's business, dividends (initiation of a new payout, or a significant boost to an existing dividend stream, or even a special dividend), share buybacks, or in some cases, whetting the appetite of potential acquirers. Bottom line: Cash is good. Oddly, though, the merits of cash aren't always appreciated in the equity market. Sometimes, there are legitimate concerns, such as situations where a distressed company is burning through its cash simply to fund operations. At other times, the market may have turned so bearish on the basic business that the stock is consigned to the scrap heap unless and until business improves or a special-situation angle surfaces (e.g. a big stock buyback).
I created a simple stock-screening strategy designed to identify cash-rich companies whose stocks may benefit from a specifically-identifiable performance catalyst. I started by limiting consideration to firms included in the Russell 3000. I then eliminated Financial (where cash is a basic operating asset) and Biotech companies (where a large cash position may be earmarked for specific development purposes rendering it unavailable for the kinds of special-situation developments cherished by investors). I also eliminated perennial cash-burners by requiring cash from operations to have been positive over the course of the last three 12-month periods. Finally, I limited consideration to situations where net cash (cash and equivalents minus total debt) per share amounted to at least 35% of the current stock price. To identify a stock-market catalyst, and to limit consideration to a manageable number of stocks, I sorted the list based on change in analyst sentiment, defined as percentage reduction in weighted averages of the standardized values assigned by data vendors to analyst recommendations (Buy, Strong Buy, etc.) and selected the top (most bullish) five.
Backtests conducted on StockScreen123.com, which presumed that the lists would be refreshed every four weeks, showed that a portfolio based on this strategy over the past five years would have converted $1,000 into $4,616, versus $949 for the Russell 3000; over the past two years, the strategy would have converted $1,000 to $1,768, versus $1,236 for the benchmark. There's a lot of turnover (most months, four or all five positions need to be replaced) and there were some dry spells during the test periods (for example, October 2010 through 2011 was forgettable with the strategy more or less matching the benchmark). But even if buying the list isn't a slam-dunk decision, one could at least use a screen like this as an idea generator (i.e. time spent researching names that appear on the list might prove far more productive than time spent digging into ideas that surface through a less-disciplined approach).
Here are the five stocks that currently make the grade:
Wet Seal (WTSLA)
Market Capitalization: $279 million
Cash portion of stock price: 53%
Apparel retailing can be a great business for stock trading given that most players are hot at some points in time and cold on other occasions. But WTSLA, a mall-based retailer of fashionable apparel to teenage girls and women in their 20s, is a horse of a different color. It seems to have gotten so used to the cold that its executive team might possibly be able to stroll along an arctic ice patch wearing shorts and T-shirts, assuming they could keep their jobs long enough to travel there. In August 2012, a CEO who was on the job just about a year, was shown the door as have some board members and most recently, one of the company's top merchandising executives resigned. This turnover is being spurred by an activist shareholder, The Clinton Group. There is no way to predict for sure what will happen next at this retailer and to its long stagnant sales and declining comparable-store trends. But a large cash position, an activist shareholder, and activism-induced board and executive turnover seem an interesting recipe for a "special situation" one can buy and save to a little-used USB drive. (Cut me some slack, here: We need to find a new metaphor to replace the obviously-obsolete image of a patient investor buying shares and locking the certificates away in a drawer.)
Research In Motion (RIMM)
Market Capitalization: $4.3 billion
Cash portion of stock price: 49%
Oy vey! As a once-dedicated but now-disgusted BlackBerry user, I have to say I really don't like RIMM at all. They seemed terrific back in the day when operating systems could be as complex and/or as clunky as developers felt like letting them be, given that so many customers were corporate types who could address problems by handing their phones to their respective I.T. departments saying "You deal with this thing!" as they strode away reaching onto their pockets for the personal cellphones they preferred but were discouraged by I.T. from using when on company business. But that model has been eroding as phone providers found it necessary to be responsive to customers who didn't have I.T. departments on which they could foist their problems (whether because they are consumers or because they work for firms that simply don't have I.T., or firms that have I.T. departments that have become too busy to wrestle with RIMM engineers). And frankly, I shudder to imagine what anyone at RIMM was thinking when they introduced the little piece of junk also known as the BlackBerry Storm (Can you imagine people there sitting around a conference room passing one around the table saying "Oh Yeah, Apple is toast!"). Now, they say they have a hot new thing, BlackBerry 10. I have no idea if there's anything to that. But here are some things I do know: RIMM has a lot of cash. The stock is swathed in incredibly low expectations. There are people out there who still think the name BlackBerry means something (presumably, sentimental professionals and kids who like the Instant Messenger). And there are a lot of others, especially unhappy shareholders, who wonder if RIMM should continue to exist as an independent company. Spice it all with some analyst upgrades, and this seems like another recipe for a special situation to store on the USB drive.
Market Capitalization: $142 million
Cash portion of stock price: 41%
What's the worst sentence one can possibly read in an About-Us page on a corporate web site? How about this: "Wow. To think it all began as a nifty-little idea back in 1999." I was tempted to abandon PRSS right then and there, but stayed with it only because one of the covering analysts was listed as being from Sidoti & Co. (I know and used to work with the firm's founder and his top-two lieutenants. I have enormous respect for the quality of their work and know that they'd never waste their time covering fluff-ball garbage). The "nifty-little idea" was an easy way to apply printing to T-shirts but before laughing at this being the basis for a publicly-owned company; you really need to check the web site (http://www.cafepressinc.com/brands/cafepress/) and look at how they evolved. They print on caps, mugs, cases, other kinds of clothing, wall-art. You can buy art work applied to canvasses or posters, you can have your own pictures presented as art, personalized stampers or invitations, etc. I'm tempted to go back to spend $15 on the mug that says "Pessimist: the Glass is Half Empty; Optimist: The Glass is Half Full; Accountant: Does the Glass Really Need all That Water?" Basically, this is a gift-novelty company, but a very interesting - and modern - one. PRSS has been public for less than a year, but that's been enough to allow management to experience the joy of seeing the stock pounded in response to a disappointing earnings report and lowered guidance. But with near-term expectations reigned in (something that may happen to a lot more companies this upcoming earnings season), a P/E of about 12 times estimate EPS for the current year, a lot of cash, and an niche business model, it might be worth a shot.
Rudolph Technologies (RTEC):
Market Capitalization: $311.2 million
Cash portion of stock price: 39%
Given that this company sells products used in the manufacture of microelectronics products (in connection with defect inspection, metrology which is a fancy name for measurement, and process-control software), there's a lot of risk here. This business has always been characterized by very sharp ups and downs, and risk is enhanced in this case by concentration: large customers (accounting for at least 5% of total sales) contributed 43.6% of 2011 revenue. But if a firm is to operate in a risky area, as many do, at least the one RTEC is in a pretty good one. Its prospects are heavily tied to "advanced packaging" which in the context of its business, refers to the way microelectronics (more and more micro all the time) are packed together for such growing uses as mobile electronics devices and automotive electronics. In theory, companies like RTEC might want to hang onto cash to enhance survivability, and I'll assume the company will always try to retain more than would be the case if it were in a more stable field. Even so, RTEC is profitable and it probably has more of a stockpile now than it really needs, which could spark special-situation interest in its shares.
Market Capitalization: $3.4 billion
Cash portion of the stock price: 39%
If I said "Oy vey" in response to seeing RIMM make my screen, a desire to be courteous to the editors precludes me from truly expressing my feelings about seeing AOL; yes that AOL, the one that used to be America OnLine and then Time Warner/AOL - the company that once deluded itself (and some analysts and investors) into thinking it was going to rule the internet by having users pay AOL so AOL would limit their internet experience to those AOL chose to provide and by forcing content providers to grovel to be among those AOL chose to display, and later went on to delude itself into the idea that it would also become a traditional-media powerhouse. (Did you notice how many times I said AOL? It fits. I used to work with companies that had to negotiate with AOL and that process was quite literally, all AOL, everything for AOL and if you weren't AOL you could . . . let's not go there.) Well, we all know how all that turned out. (Hee, hee!) Today, AOL is a much humbler and more "normal" (best word I can think of) web portal that provides general internet content on an advertiser-supported basis (the old subscription business still exists but continues to wither away).
The good news is that it's the sort of stuff internet users really do like to see (news, weather, movie listings, e-mail, etc. etc. etc.) The bad news is that users can get also get it on many other sites (and via mobile devices) from rivals that aren't burdened by the decade-old scorn that many still associate with the AOL name. But to the company's credit, current management (not the same folks as in the bad old days) understands the need for unique offerings (and has tried to accommodate through Huffington Post and more local-oriented content) and to keep up with the times (it introduced a games portal and has a videos portal). Although the modern company is far from setting the world on fire, its business trends are tolerable (even ex a big gain from an asset sale in the latest quarter). At 25 times estimated 2012 EPS, the P/E isn't eye-catching, but remember the cash! If the economy can get going, advertising will likely benefit, so those interested in playing the consumer in general or new media in particular may find that the cash (and the possibilities one might imagine, whether more Huffington-like acquisitions or share buybacks) justifies at least some consideration of AOL, at least as a companion with Yahoo (YHOO), which has a lower P/E but quite a bit of its own baggage given its recent management shakeup and never-say-die dreams of chasing Google (GOOG) in search-advertising.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.