Understanding the Joy of Cash

 | Apr 02, 2013 | 12:00 PM EDT  | Comments
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Investors can be odd in their behavior toward the market. That behavior often is in stark contrast to what would make sense normally. For example, as the stock market is rising, more and more money is being invested. As the markets decline, more and more money gets pulled out. This peculiar behavior seems to exist only with respect to securities investing.

If you are an avid golfer and your favorite golf balls go on sale, what do you do? I'll tell what you don't do -- you don't wait for the sale to end, believing that at higher price, the same golf balls are now of higher quality. You load up while the sale is in effect. You follow the same rational behavior when groceries or your favorite fashions are on sale.

When things aren't on sale you don't buy as much, or in some cases you hold your cash and wait. The problem with investing is that cash becomes more and more hated when it sits idle, earning nothing, and other assets are appreciating. I would tell investors today that having cash is indeed a rational investment decision. Do attractive investments exist today? I would say yes, but the risk of a market pullback is also elevated. So if you are tempted to buy Apple (AAPL) today at $428, make sure you have plenty of cash to buy some more at $375.

That's the joy of having cash -- being able to buy an attractive investment at a great price and then being able to buy more at even lower price. If you don't have cash, then guess what? Chances are good that you will have to sell back that attractive investment at an even lower price in order to raise cash.

I can't predict the future. There are many analysts who predict that the S&P 500 will eclipse 1600 this year and just as many analysts who see the S&P falling back below 1450. Take your pick. But it's noteworthy to consider the following information. According to Value Line, the current median price/earnings ratio of stocks today is 16.8. At the market low in March 2009, the median P/E was 10.3. At the market high in July 2007, the median P/E was 19.7. The median dividend yield of all dividend paying stocks under Value LIne's review is currently 2.2%. In March 2009, the median yield was 4%; in July 2007, the yield was 1.6%.

While these numbers perhaps reveal another 10% to 15% upside before reaching the July 2007 highs, we can't forget that the biggest catalyst pushing stock prices up today is interest rates. We must remember that those interest rates are not natural but are being suppressed by the Federal Reserve.

Cash is indeed king. Cash gives you the ability to make decision on your own terms and not through the forced actions of the market. Warren Buffett got the deals with Goldman Sachs (GS), Bank of America (BAC) and General Electric (GE) not only because he was Buffett, but precisely because he had billions of excess cash to put to work. You may not have been able to get the preferred stock, but had you bought Goldman when Buffett struck his deal, you would be up over 60% today. BofA was trading for $7 when Buffett invested. It is now trading for more than $12.

The short-term annoyance of having idle cash earning nothing is a reasonable price to pay for future opportunities. It's an opportunity cost that can't be calculated today, but clearly holds enormous future value.

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