Share the Wealth, Part III: Our Final Four Cash-Rich Companies
Today we conclude our three-part series examining the companies with the biggest bank accounts, and whether they are worthwhile investments for the upcoming New Year.
|Company (Ticker)||Cash/Near Cash|
|General Electric (NYSE: GE)||$61.4 Billion|
|Berkshire Hathaway (NYSE: BRK-B)||$26.9 Billion|
|Ford (NYSE: F)||$25.8 Billion|
|Merck (NYSE: MRK)||$21.8 Billion|
|Oracle (Nasdaq: ORCL)||$16.2 Billion|
|Hewlett-Packard (NYSE: HPQ)||$13.3 Billion|
|Dell (Nasdaq: DELL)||$12.8 amargin829llion|
|ExxonMobil (NYSE: XOM)||$12.5 Billion|
|Google (Nasdaq: GOOG)||$12.1 Billion|
|Johnson & Johnson (NYSE: JNJ)||$11.9 amargin757llion|
In Part One, we studied General Electric (NYSE: GE) and Warren Buffett’s Berkshire Hathaway (NYSE: BRK-A). Part II gave us the opportunity to delve into Ford (NYSE: F), Merck (NYSE: MRK), Oracle (Nasdaq: ORCL) and Hewlett-Packard (NYSE: HPQ).
We’ll look at four companies today, all of which are household names. Computer giant Dell (Nasdaq: DELL), search pioneer Google (Nasdaq: GOOG), drug maker Johnson & Johnson (NYSE: JNJ) and petroleum titan Exxon Mobil (NYSE: XOM), which holds the distinction of being the most profitable company in the United States.
No. 7: Dell Inc. (Nasdaq: DELL), $12.8 billion
Selling computers is a tough racket.
Computer manufacturers must deal either with finicky consumer tastes or with corporate customers whose technology budgets are dependent on a fickle economy. Neither group is easy to plan for. Both demand the latest technology and shop almost entirely on price. As if those business conditions didn’t add up to low enough margins, the whole enchilada rests squarely on continual and expensive ad campaigns. The result is that Dell, the No. 2 computer maker, takes in scads of revenue — about $60 billion a year — but gets to keep relatively little of it.
No company can afford to rest long, but the technology sector is known for especially intense, NBA-like competition. In the fight to sell computers, Dell can’t even afford to blink. Hewlett-Packard is a relentless opponent. Upstart competitor Acer constantly nips at Dell’s heels. And then Asustek came along and had the idea of making computers even cheaper with its stripped-down netbook, an idea that totally remade the industry almost overnight.
Dell makes decent computers and sells them cheap, but its investors never get anywhere. That’s clear from the static shareholder equity line. Ideally, a company should maintain a reasonable cash position and use some of its free cash flow to reduce debt over time. Dell simply can’t do this for one simple reason: It doesn’t have enough money. Its cost of goods and operating expenses mean a razor thin operating profit of just 5.2%. Apple (Nasdaq: AAPL), whose consumers do not shop on price, maintains a 21.0% operating margin. And, surprise, the company’s balance sheet is not only devoid of any long-term debt, its shareholder equity line continually grows. Dell will never be able to match Apple’s model.
That’s the cost of competing on price.
Dell is fairly valued and looks poised to deliver lackluster earnings of $0.97 in the year ended Jan. 31, 2010, about 50 cents per share less than its recent good years. At 14 times earnings, Dell’s current valuation exceeds its two-year average. Going forward, the consensus estimate of $1.21 seems to err on the side of optimism for an economic recovery, and even if it is dead-on it implies only a modest +7.4% upside at its historical valuation.
Cash is great if it can be used to generate significant profits. Dell can’t do this and, importantly, it never will be able to. I think investors should look elsewhere.
No. 8: ExxonMobil Corp. (NYSE: XOM), $12.5 billion
ExxonMobil is worth $354.9 billion. Last year’s revenue, at $460 billion, exceeded Wal-Mart’s (NYSE: WMT) by a wide margin. Exxon posted net earnings of $4.7 billion last quarter alone — enough to buy Hasbro outright — and $13.3 billion in the first nine months of this year, which would add two aircraft carriers to the Navy’s Pacific Fleet.
The most surprising thing about Exxon, given these humongous numbers, is that it doesn’t have more cash. After all, its cash line is roughly equal to this year’s profits. So investors, when looking at Exxon’s books, need to ask one critical question:
The answer lies in management’s laser-like focus on the future.
Now, don’t worry. I’m not going to launch into some diatribe about how the world’s biggest oil company is spending gazillions on harnessing tidal energy to bring about cheap power and world peace. While Exxon certainly invests substantial sums in “green” energy — it recently committed $600 million to an algae-based biofuel program — its main focus remains on finding more crude and acquiring the rights to it.
This is the first and most important thing this company does, so it’s not surprising that it’s the first topic of the annual report. Here is what the company said as it reported its 2008 results: “By 2030 global energy demand is expected to increase by about 30 percent from today’s level, even assuming significant gains in energy efficiency. Oil and natural gas will remain the world’s primary energy sources, meeting close to 60% of the demand. ExxonMobil plans to invest more than $125 billion over the next five years developing future energy supplies.”
It is this investment that will be the future of the company. That’s where most of its cash goes, and that’s what every investor must focus on — not the price of oil, not the current state of global petroleum demand. What matters is not what it’s selling today, but what it will sell five years from now.
“Upstream” earnings (refineries and gas stations are “downstream“) accounted for $35.4 billion of Exxon’s $45.2 billion in 2008 earnings. If Exxon were to begin to deplete its reserves, then it would become a vanishing asset. This is not the case, though: The company succeeded in replacing 103% of its production, adding 1.5 billion barrels of oil equivalent to its reserves. Here’s how Exxon uses its cash: To buy reserves that will generate more cash. Last year it spent $26.1 billion on capital expenditures and exploration. It currently has 72 billion barrels of reserve capacity. These upstream assets require a lot of cash, but that cash earns a remarkable return — 54% in 2008 and an average 44% during the past five years.
The earnings potential is the bottom line, and the most important thing for investors to keep in mind. I know of no other company that gets more bang for its buck. Because of this, I consider Exxon to be an outstanding long-term investment.
No. 9: Google Inc. (Nasdaq: GOOG), $12.1 billion
If I had to pick the worst business decisions ever made, taking Google public would be near the top of my list. It’s not like the company ever had any trouble raising capital: Sun Microsystems (Nasdaq: JAVA) co-founder Andy Bechtolsheim wrote Larry Page and Sergey Brin a check for $100,000 to get the entity going even before it had been incorporated. Sequoia Capital and Kleiner Perkins came through with $25 million about a year later. In 2004, the company sold 19.6 million shares for $85 isinh in a $1.7 billion IPO.
The company is now worth $180 billion. Page and Brin, had they kept the company private, likely would be No. 1 and No. 2 on the list of the richest people in the world, with a net worth of perhaps $80 billion each, instead of sharing 11th place, at (a paltry) $13.3 billion.
Google derives 96.8% of its revenue from advertising. And today the shares hit a 52-week high, which seems to indicate a rosy outlook for advertising. Wall Street was pleased to see that the revised unemployment figures came in lower than were previously estimated, which the market evidently interpreted as a sign the economy is turning around and that advertising will pick up.
Google is the most richly valued company of the stocks on our list. Investors are willing to pay 5.5 times net assets (or “book value“) for the shares, a significant premium to the 2.2 times book value that the overall S&P 500 commands. The reason Google’s price-to-book ratio is so high is the same reason its P/E ratio is high: Investors expect Google to continue to increase its earnings. And they are willing to pay $5.50 for every dollar of assets. To put that number into perspective, investors only pay $1.20 for every dollar of Berkshire Hathaway’s assets, which means, at least mathematically, that Warren Buffett is only worth 20 cents to Wall Street.
Even at such a high valuation, Google looks like an awfully tempting buy. Its 2010 revenue is estimated at $26.19 per share, and even a relatively low earnings multiple of 30 implies a fair-market price of $785.70. That’s about +35% above today’s prices, and it’s an exceedingly low estimate: These shares routinely are worth 40 times earnings, not 30.
Investors can rest assured that Google will use its cash to continue to build its business. It certainly doesn’t need to use it to service debt, as the company doesn’t have any. Google’s primary focus going forward will be in expanding the reach of its advertising in the United States and in developing its presence in the rest of the world.
Investors who aren’t afraid of tech likely would be pleased with these shares, and they won’t need to commit to the long term. In the next year, these shares should roughly triple the long-term average return of the S&P 500. If you buy them, however, please hold them for at least 366 days. Not to give my prediction more time to come true, but to help you avoid some capital-gains taxes.
No. 10: Johnson & Johnson (NYSE: JNJ), $11.9 billion
More years ago than I care to remember, I — a young copy editor — walked into the deputy managing editor’s office at The Star-Ledger, the largest newspaper in New Jersey and one of the best papers in the country. As much as it pains me to admit it, the guy was brilliant (he’s now the executive editor) and he oversaw a great sports department and a business section that broke news in a tough market, where our competitors were The New York Times and The Wall Street Journal. I can’t remember what we were initially talking about — I suspect it was rank insubordination — but I wound up betting him that Johnson & Johnson would miss earnings.
A few days later, I paid up on the modest wager, which was probably bad Chinese food from across the street, and I heard a bit of advice from my boss’s boss’s boss: “Don’t ever bet against Johnson & Johnson. Just don’t do it.”
It has become one of the commandments I live my life by, along with: Never bet on a horse named after a blonde, never draw to an inside straight and never eat at place called Mom’s.
Good rules, all.
Johnson & Johnson is one of the most looked-up-to companies in the world. According to the Reputation Institute, Forbes reports, J&J is the company that Americans esteem, admire and respect the most. Its composite score of 83.6 on a 100-point scale was 2.5 times higher than Kraft (NYSE: KFT), which took a distant second in the ranking. (Oil-field service company Halliburton (NYSE: HAL) scored lowest out of the 153 companies ranked, and that’s a bum rap. HAL’s a great company. It’s also up +53% so far this year.)
As I learned from my ill-fated wager, Johnson & Johnson can be counted on to deliver results. It’s posted an annual earnings increase since at least 1998 and has beat Wall Street expectations for the past 15 quarters. Its earnings did not slip in the recession, which suggests an uncommon resiliency. And yet it is not a juggernaut by any stretch of the imagination: For the past four years, J&J’s revenue has posted a modest +6.0% compound rate of growth. Its net earnings have fared somewhat better: They’ve grown at a compound rate of +6.5%. Given its immense revenues — some $60 billion a year, this feat is not only laudable but impressive. The company maintains a 25.4% operating margin.
Johnson & Johnson makes hundreds of health-care related products, including scores of medical devices like heart stents, diagnostic tools and about two dozen prescription drugs. Its consumer line-up includes such ubiquitous products as Band-Aids and the baby powder and No More Tears shampoo that all moms use.
As Johnson & Johnson moves forward, it will deploy its cash in acquiring companies to add to its product line, which currently has only five products in late-stage clinical trials. As Big Pharma goes through a wave of mergers — the Pfizer-Wyeth deal, Merck’s acquisition of Schering-Plough — a takeover seems ever more likely, though it might be more natural for J&J to focus on devices or diagnostics than pharmaceuticals.
Frankly, J&J needs a deal. J&J has a great reputation as a company everyone loves and it makes products we all use, but investors are ho-hum about the company’s prospects. A deal might add some excitement, the sale of a division might unlock the value of a particularly dynamic business unit.
I learned my lesson, and I’m not going to bet against its earnings, but I’m not wild about J&J’s stock, either. If 2010 delivers the consensus earnings estimate of $4.92, the company’s fair-market value is only about $69, not much of a premium from today’s $64.36. It may have a vast cash hoard, but it doesn’t look like a particularly compelling buy for the New Year.