News Analysis date published New: 
Tuesday, July 10, 2012 - 13:00
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Tuesday, July 10, 2012 - 17:05
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Tuesday, July 10, 2012 - 13:00

2 Cash-Rich Stocks That Should Make a Great Trade

Tuesday, July 10, 2012 1:00 PM

The old cliche of cash being king is actually quite accurate. This is particularly true in times of economic uncertainty. Cash enables companies to act quickly on opportunity, to avoid debt and to continue to maintain a high level of operation during slow periods. It is the lubricant that keeps the wheels of business turning.

Companies that have been successful enough to accumulate large cash reserves are definitely worth a closer look as potential investments. There are several fundamental metrics an investor can utilize to clarify a company's cash strength. My favorite of these metrics are the quick ratio and current ratio. While these two metrics are way less popular than earnings per share (EPS) or return on assets (ROA), I have found knowing them is key to a thorough understanding of the fundamental picture.

Determining the current ratio is as simple as looking on a company's balance sheet. It is calculated by dividing current assets by current liabilities. This ratio is also known as the liquidity ratio, cash asset ratio or just the cash ratio. It is used to calculate the company's ability to pay back its short-term liabilities (bills, debt, etc.) with its short-term assets. The higher the current ratio, the more capable the company is of paying back its obligations.

If the current ratio is less than one, then be very cautious. It clearly indicates the company is lacking ready cash or quickly convertible assets. This could potentially signal trouble on the horizon. If it's greater than one, then you should feel relatively confident about the company's cash situation.

The quick ratio is similar to the current ratio, but provides a more conservative picture of the company's cash health. It is calculated by subtracting inventories from current assets then dividing by current liabilities. Excluding inventories makes this ratio more conservative than the current ratio, because many companies have a difficult time in quickly converting inventory into cash. Just like the current ratio, the higher the quick ratio, the stronger position of the company.

I ran fundamental screens searching for cash-rich companies for potential investment. My search for large-cap stocks with a quick and current ratio greater than three has turned up several very interesting names across multiple sectors.

Here's what I found…

1. Intuitive Surgical (Nasdaq: ISRG)

This cutting-edge medical device maker boasts a quick ratio of 4.20 and a current ratio of 4.58.

These numbers, combined with an EPS growth rate of 30%, paints a tremendous fundamental picture for this provider of micro-surgery system. But the stock has a high sticker price at just above $560 per share. In the case of ultra-high stock prices, I like looking at longer-term options or warrants to benefit from continued price growth at a lower cost.

The January 2013 $600 strike price call option, at the present trading price of just under $31 per contract, and the January 2013 $550 strike price call options at just above $50 per contract, look appealing.

2. Chipotle Mexican Grill (NYSE: CMG)

I'll be the first to admit I absolutely love eating at Chipotle. The burritos are outrageously good with the organic chicken and other fresh, natural ingredients. Rarely have I had a disappointing dining experience at one of the multiple locations I have been to for a quick lunch over the years.

Chipotle has a quick ratio of 4.35 and a current ratio of 4.43. When these respectable numbers are combined with an EPS growth rate of nearly 20%, it creates a compelling picture. This is another high-priced, high-performance company. Once again, I prefer to lessen my cash outlay when buying these types of companies by purchasing call options. The January 2013 $400 calls are attractive at about $27 per contract.

Risks to Consider: Despite being cash-rich, solid companies, these fast-moving expensive stocks can experience quick declines. Always position size properly and use stops. In addition, should you decide to go the option route, be aware there are many factors that determine option prices, therefore option trading is only suitable for sophisticated investors who understand the risks involved.

Action to Take --> I like both these companies. My strategy with Chipotle is to go long on the stock, on a break above the $390 level with either the stock or the $400 strike price, January 2013 call option.

With Intuitive, I like trading a channel between $550 and $571. This means is I will go long on a pullback to $550 or buy on a breakout above $571. In other words, I will stay flat (or do nothing) in the channel in between. If the pullback trade is triggered, then the January 2013 $550 calls are the weapon of choice. The breakout trade would make the January 2013 $600 calls my choice.

David Goodboy does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.