Warren Buffett used to define a "margin of safety" as a company that was trading close to – or even below – "breakup value."
Of course, that metric doesn't work as well today – especially in the parts of the tech sector that we like to focus on: You just aren't going to find many high-growth companies trading at bargain-basement levels.
But with U.S. firms sitting on a record $1.7 trillion in cash, you can find some name-brand tech firms whose cash reserves can cover a decent portion of their share price – creating a nice "margin of safety" as we move into the fall. (Good timing, considering everything that's happening – or not happening – in D.C. right now.)
I like to refer to these as "Cash is King" tech stocks.
So let's look at three that even Buffett, who typically avoids this sector, would consider…
Why Cash Is Important Now
If you've followed Strategic Tech Investor, you know I put a lot of stock in my five-part strategy for finding high-growth stocks at the lowest-possible levels of risk.
That strategy is why, in fact, that I believe "the road to wealth is paved by tech."
And Rule No. 1 – which tells us that "great companies have great operations" – addresses this very situation. That rule tells us to focus on cash flow and profit margins and is the key part of a system that I've used for decades.
Companies that are sitting on a lot of cash provide a big margin of safety against a market decline. They give investors confidence that the company is on the right track and will succeed over the long haul. And that's why investors are less likely to sell in a panic at the first sign of trouble.
This isn't all about sentiment, either. Solid cash flow is a great way to lower what I consider to be the "true cost" of buying a stock. There's even a simple mathematical formula for figuring this out. Simply take the stock's "sticker price" – what it's selling for – and subtract its net cash per share.
Let me show you what I mean.
Let's say a stock is trading at $24 a share. But the company holds net cash of $6 a share. That means that your true cost is closer to $18.
In other words, if the company liquidated tomorrow (outside of bankruptcy court), as a shareholder you're entitled to that $6 a share because it's your money.
It's just like getting the stock at a 25% discount.
And that's an implied margin of safety.
And here's another great thing about cash-rich tech leaders. They can use that money to do three things that will only benefit you as a shareholder.
The company can:
- Pay dividends or increase the payout ratio.
- Buy back shares, a move that can push the stock higher on its own.
- And buy other firms in a way that can improve future growth and help the company expand into new markets.
With strong cash flow as our guide, let's take a look at three tech firms that have a huge amount of cash on hand already – and are most likely to add to their war chest with the hefty cash flows they generate.
About the Author
Michael A. Robinson is a 36-year Silicon Valley veteran and one of the top technology financial analysts working today. That's because, as a consultant, senior adviser, and board member for Silicon Valley venture capital firms, Michael enjoys privileged access to pioneering CEOs, scientists, and high-profile players. And he brings this entire world of Silicon Valley "insiders" right to you...
- He was one of five people involved in early meetings for the $160 billion "cloud" computing phenomenon.
- He was there as Lee Iacocca and Roger Smith, the CEOs of Chrysler and GM, led the robotics revolution that saved the U.S. automotive industry.
- As cyber-security was becoming a focus of national security, Michael was with Dave DeWalt, the CEO of McAfee, right before Intel acquired his company for $7.8 billion.
This all means the entire world is constantly seeking Michael's insight.
In addition to being a regular guest and panelist on CNBC and Fox Business, he is also a Pulitzer Prize-nominated writer and reporter. His first book Overdrawn: The Bailout of American Savings warned people about the coming financial collapse - years before the word "bailout" became a household word.
Silicon Valley defense publications vie for his analysis. He's worked for Defense Media Network and Signal Magazine, as well as The New York Times, American Enterprise, and The Wall Street Journal.
Michael is 100% independent and receives absolutely no compensation from companies he writes about. His ideas are completely his own.
So, it probably goes without saying that you won't ever be left in the dark about breaking innovations, ahead-of-their-time technologies, and breakout companies on the cusp of changing the world once you join this world.