Having plenty of cash gives a company flexibility and safety. Companies with lots of cash can pay their debts more easily, which means creditors are less likely to take control away from the owners. During tough economic times, cash lets companies keep working on important projects like research, development, and improvements, so they’re ready when the economy picks up again.
Companies with extra cash have a few options. They can pay dividends to shareholders, but this means the money is taxed twice—once when the company earns it and again when shareholders get it. To avoid this, many companies buy back their own shares. This can make the stock price go up because there are fewer shares available, and it can also increase the earnings per share.
They can also use cash to grow their business by developing new products or buying other companies. Having a lot of cash can also make a company a tempting target for buyers since the cash effectively lowers the price someone would pay.
While cash is good to have, it can also hurt profits. Cash usually earns less money than other investments a company might make. So, holding too much cash means the company might not be making as much profit as it could.
Also, companies holding a lot of cash are often in mature industries that aren’t growing much. These companies don’t need to spend a lot on new projects, so good management is crucial to make sure the cash is used wisely.
Companies report their cash amounts regularly. One way to measure cash is to divide the total cash by the number of shares to get cash per share. Comparing cash per share to the stock price shows how much of the company’s value is backed by cash.
For example, General Electric has $6.1 billion in cash and 3.28 billion shares, so it has $1.86 cash per share. Since its stock price is about $130, cash is only a small part of its value.
Some companies, especially those that do well when the economy is strong but struggle in downturns (like car makers), save cash during good times to help them survive when times are tough. For example, General Motors has a large cash reserve, which helps them get through difficult periods.
Investors can look for companies with a high cash amount compared to their stock price—ideally where cash is at least 20% of the stock price. It’s best to skip financial companies and utilities because they naturally hold a lot of cash.
Other things to check include:
It’s important to also consider the company’s debts. Subtracting short-term debts from cash gives a better picture of how much “extra” cash the company really has. Companies with high net cash compared to their stock price are better cash-rich investments.
Finding companies with lots of cash isn’t enough. You also need to look at their debts, growth potential, and how well they generate cash over time. Ultimately, the company’s management must be good at using that cash to help the business grow and create value for shareholders.