I was re-reading Phil Fisher’s Conservative Investors Sleep Well and was going through the “What About Dividends?” chapter (which is also included in his book Common Stocks and Uncommon Profits as well) when I came across a Fisher quote on cash-rich companies that I did not remember encountering the first time through:
“When do stockholders get no benefit from retained earnings? One way is when managements pile up cash and liquid assets far beyond any present or prospective needs of the business. The management might have no nefarious motive in doing this. Some executives get a sense of confidence and security from steadily piling up unneeded liquid reserves. They don’t seem to realize that they are buttressing their own feelings of security by not turning over to the stockholder wealth that he should be entitled to use in his own way and as he sees fit. Today there are tax laws that tend to curb this evil so that, while it still occurs, it is no longer the factor it once was.”
This is one of the few areas where I disagree with Fisher. I love looking at cash-rich companies like Apple or Berkshire Hathaway. I love seeing that Visa has no debt on its balance sheet. I suppose, though, it comes down to how you choose to define the word “prospective needs.”
The point of sitting on tons of cash is that you maintain control. Do you know why Wachovia fell during the financial crisis in 2008? They had been conservatively run for decades and had built up a book value approaching $40 per share yet went under simply because credit froze up and they did not have enough cash on hand. A similar story played at Lehman Brothers; over one hundred years of legendary history disappeared in the flash of a few days simply because the company did not have enough cash on hand.
We know about Warren Buffett’s legendary investments in Goldman Sachs and General Electric. Any way you analyze that transaction, it was all about cash. Because Buffett keeps $30-$40 billion in cash on hand at Berkshire, he was able to lend billion-dollar lifelines to the two iconic American firms. Of course, you could legitimately argue that such a lifeline extension was part of Berkshire Hathaway’s “prospective needs”, and thus, fit Fisher’s definition.
The point is that having a lot of cash on hand is a huge form of protection. You can’t run into financial trouble if you are drowning in cash, and you put yourself in a position to take advantage of opportunities if you have the ability to write a big check when moments of distress arive. Let me put it this way: imagine how frustrating it would be to recognize that energy MLPs were dirt cheap in late 2008 and early 2009 but not having the ability to actually do anything about it because your money was already previously spoken for entirely with other investments.
Imagine how pitiful it was for General Electric and Goldman Sachs to go begging to Warren Buffett for billions of dollars so they could keep their companies functioning and remove the risk of a liquidity freeze. On his song “Wrecking Ball”, there is a reason why Bruce Springsteen repeats the line “Hard times will come, and hard times will go” five times in a row—economic booms and busts are part of economic life.
It’s your job to spend the good days saving up money so that you can be on the Warren Buffett side of the table during the next 2008-2009, rather than the General Electric or Goldman Sachs side. Not only are the investments made under those situations economically lucrative, but it’s a better way to live—it’s a higher quality of life to be looking for cash to deploy rather than having to beg for money when crisis arrives.
Fisher didn’t like it when companies stockpiled cash. He wanted that money to get put to productive use to make shareholders rich. He wouldn’t have liked Steve Jobs stockpiling billions of dollars in Cupertino, California to build up Apple’s supreme economic strength. Personally, I don’t think investors or entities ever come to regret having fat stacks of cash on hand. When economic recessions come, as they always do, I don’t think any individual investors or corporate executives regret checking in which a bank to see a bulging cash balance. Productive assets are very important, but so is freedom and having options, and cash alone can truly provide those two things during periods of economic distress.
Originally posted 2014-01-27 08:04:19.