Cash does not add to investor appeal

‘Cash is king' is the general perception. But does betting on companies sitting on piles of cash earn you a good return in the stock market?

Not really so! Analysis shows that no matter how adventurous investors may be, they seem to assign more weight to a company's growth prospects determined by the business and sector it operates in, than to its idle cash coffers.

Deceptive picture

Suppose you were looking for good investment candidates six years ago, in March 2006. Scanning the cash balances (cash, deposits and mutual fund holdings according to the balance sheet) on that date, you would have arrived at a list of 20 companies topped by Financial Technologies, Rajesh Exports, Abbott Labs, NMDC and Gateway Distriparks.

Nearly half these companies have failed to match the broader market (BSE 500) return in the six years till date. And none of the 20 even figured in the top performing stocks for this period.

Nor did cash levels matter when it came to choosing between two companies within a sector. In March 2006, NMDC, with cash to total assets of 57 per cent, had much more cash than Sesa Goa (a third of assets). But despite NMDC's higher profitability and cash reserves, Sesa Goa comfortably trounced it in the stock market, with returns of 292 per cent against NMDC's 172 per cent.

Way back in 2006, FMCG behemoth Hindustan Unilever had cash accounting for 23 per cent of its assets, while small-time challenger Marico had just 9 per cent. Yet in terms of stock price returns, Hindustan Unilever ranks the lowest with 41 per cent return in the six-year period, while Marico trebled. Here again, cash certainly was not king, in fact it would have left the investor with an underperformer.

Ditto was the case with the tech majors TCS and Infosys. In March 2006, TCS saw cash account for a mere 13 per cent of its total assets, dwarfed by Infosys which saw cash account for 45 per cent. Yet when it came to performance on the bourses, TCS comfortably outdid Infosys with a 154 per cent return versus 92 per cent from Infosys.

Sector prospects

Cash also matters little if a sector takes a nosedive, leading to poor profit prospects. Take aluminium majors Nalco and Hindalco. If you were looking to buy them six years ago in March 2006, both were quite cash-rich, with Nalco holding 30 per cent of its total assets in cash and Hindalco sitting on 18 per cent.

But both have turned out to be dud investments. Nalco has shed over 8 per cent and Hindalco 6 per cent in six years while the market zoomed 52 per cent. The lesson is that in a cyclical business with volatile earnings, cash is seldom a saviour from underperformance. Several commodity players have seen their cash reserves account for a higher portion of their total assets but their stock prices swing with the commodity cycle.

Cash per share

This may also be the reason why selecting stocks based on the measure of ‘cash per share' does not seem to work.

An analysis of BSE 500 companies shows that even today, a fair number of listed companies actually trade at a market capitalisation that is lower than the cash on their balance sheets. The names on this list include Geodesic, Rajesh Exports, GTL Ltd, Polyplex Corporation, Edelweiss Financial Services, Network18, Firstsource and Shree Ganesh Jewellery House. But cash is apparently no guarantee for investment success. Six of these eight companies have not been good investmentsduring the six years. The question for investors in these cases is whether the company's core operations can generate sustainable profits.

Take the case of Rajesh Exports, a player with Rs 265 per share in cash (the share price is Rs 139). It has reported losses from its core business in recent years and would not be profitable but for ‘other income' from its cash kitty. This raises the question as to how the company sustains its growth in the event of limited accretion to its cash balances.

Cash vs returns

A more visible example of plain cash being undervalued in the market is that of Piramal Healthcare. The company sold its formulations business to Abbott a couple of years ago. It has been receiving the Rs 17,000 crore in staggered payments. The company has, however, traded at valuations in the Rs 6,000-10,000 crore range, never reaching the valuation watermark of its implied cash holdings. Neither a special dividend nor a buyback enthused investors.

The company has deployed part of its proceeds to picking up a stake in Vodafone. It hopes to profit by holding on for a year or two. However, investors seem spooked by the company's reluctance for a game plan to distribute or better deploy the cash holdings.

Ditto is the case with index heavyweight Reliance Industries. With a whopping Rs 75,000 crore in cash balances, Reliance has launched a buyback offer, made forays into hotels and media and is said to be actively scouting for other buys. But the market has simply refused to let the stock budge, with the stock being a big underperformer. The shares have gained 26 per cent in the last three years compared with a 95 per cent gain in the Sensex.

Cash, it turns out, is not the most accurate indicator of obvious investment success. A company's ability to accumulate oodles of it does not translate into great returns for the investor.

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