Morristown, New Jersey (PressExposure) May 27, 2011 -- What is a safe money investment?
Safe money investments have two characteristics -
1. Value that will last. Real, significant, durable value.
* No trendy stocks whose price is built on hype and hope.
* Companies whose assets can be turned into cash.
2. A price well below the stock's value.
* Buy bargains. If a great company is down, that's when to buy.
* Great companies bounce back from a down market or a temporary slip.
What is value in a company?
True safe money investments have -
1. Lots of cash.
* Cash keeps the business going when sales dip. It's insurance.
* Cash pays for sales and advertising.
* Cash pays for research, new equipment, and acquisitions.
* Cash pays for growth.
2. Little or no debt.
* Debt payments take money away from profitable activities.
* When times are tough, debt payments can drag a company under.
* A safe money investment can pay all its debt, with cash left over.
3. Lots of free cash flow.
* Free cash flow is the money that's left after all costs of operating a business are paid.
* Free cash flow can add to a company's cash or reduce its debt.
What is the opposite of a good safe money investment?
* A company with huge loans, searching for future earnings that may never arrive.
* A company spending more than it makes.
* Companies like that may succeed, but they often flame out.
When is a price well below the value of an investment?
Here are two definitions of safe stock prices - both work.
1. Price less than 15 times free cash flow.
* Blue chip stocks often sell for around 30 times free cash flow. Half that is a bargain. The stock could double in price.
2. Price to Sales Ratio below 0.9.
* History shows double digit annual returns for such stocks over 5 years. Price to Sales Ratio over 0.9 returns less than half that.
Two other popular definitions use the Price to Earnings Ratio (P/E), and the Price to Book Ratio (P/B). These don't work quite as well, because -
* Earnings are often manipulated.
* Book value may not reflect the value of intellectual property such as software and patents.
When to buy or sell.
The time to get out is when a stock stops being safe money. Never hang on when a company loses its value or gets too expensive. Don't be afraid to sell, even after many years.
Here's an example from a real company I'll call ZZZ to avoid bias.
* ZZZ has $20.75B in cash, and $2.5B in debt.
* ZZZ has enough cash to pay its debts with plenty left over.
* ZZZ has $8.26B in free cash flow - enough so that the company could buy itself in a few years.
* ZZZ sells for 14.1 times its free cash flow - a bargain.
* ZZZ does have a high Price to Sales Ratio of 2.72.
* The market may worry about ZZZ's relatively slow sales growth.
* With all that free cash flow, ZZZ is still safe.
The lesson is that low risk makes for big profits. Don't gamble, especially with retirement investments. There's more money playing it safe.