Companies must have a good net surplus cash
(net surplus cash = cash + bank balances + liquid investments + investment in group companies - short-term debt).
- The company must have a very low debt to equity ratio, high operating margins and operating profits, high dividend payout ratios, high cash EPS and superior returns on capital.
- There should be a consistency in cash flows in the past and the ability to generate cash for the next 2 to 3 years.
- Further, run a check on the management competencies and their ability to manage cash and put it to good use.
INVESTMENT CAVEAT
Critics point out that at this moment, cash rich companies are trading at high P/E ratios and are expensive. Besides, at the end of the day, it is valuation that ultimately matters. Against that backdrop, such stocks would fail to provide protection once the bear phase kicks in. However, when all stocks are expensive, cash-rich companies with concrete business plans could offer greater price stability and better downside protection.
CONCLUSION
As the market booms into uncharted territory, volatility is likely to increase manifold in the future. You could be better off investing in frontline stocks with strong cash flows and which hold a prominent position in their respective industries. Moreover, only look at companies that belong to sectors on which you are bullish.
IN BRIEF
- With the stock market overheated and valuations over-stretched, adopt a conservative strategy and invest in stocks that have a brimming cash kitty and strong future expected cash flows.
- Cash-rich companies can fund their expansion plans with considerable ease even in a difficult business environment.
- Such companies amongst other attributes must have a very low debt to equity ratio, high operating margins and operating profits and high dividend payout ratios.
