Cash is King in this Market

One thing you can guarantee never receiving with a Port Phillip Publishing subscription is a consensus view. Each editor is free to do his own thinking and form his own strategy. But if there is a bit of theme between them right now, we could probably boil it down to this:

Cash is king in this market.

There’s two sectors of the market where this key asset can often be in scarce supply – small caps and junior miners.

In other words, right where Diggers & Drillers and Australian Small-Cup Investigator go hunting for outsized gains.

So today’s Money Weekend will show you how editors Dr Alex Cowie and Kris Sayce see things across the board, and the strategy to use…

Beware Market Expectations
 

In the big picture, you don’t need to look much further than the world’s largest diversified miner, BHP, to see what we mean. CEO Andrew Mackenzie has put everyone on notice that the company is going to spend less on capital investment. He’s looking to increase profits via streamlining their existing operations.

In other words, he’s hanging on to more cash in the face of the soft outlook for commodity prices.

The recent trend in the market has been clearly in favour of paying out earnings to shareholders. Investors are looking at income, not growth. That’s bid up dividend paying stocks and has been a strong current driving the banks and Telstra.

Miners like BHP have to invest to survive and grow. But so do other businesses. It really boils down to four options for any company. It can use its money for capital expenditure, to pay off debt, bank the cash, or return it to shareholders.

The more they pay out earnings, the less they have to invest in their own business.

Usually, investors only bid up stocks aggressively when they see a lot of future profit and growth.

That’s why small caps and junior miners can be so lucrative. Even if they don’t earn any money, if investors think they’re on a gold mine, the shares will rise in anticipation.

One thing we’ve picked up since following markets is how sensitive they are to expectations. Beat the profit guidance and your stock soars. Miss it, and the market will take you down.

The same dynamic is playing out right now in iron ore and gold. Both are down for the year. But gold stocks have been hammered much more. That’s because the market was expecting a stronger gold price. It had already discounted soft iron ore prices.

That’s probably one reason BHP’s shares fell a bit this week but didn’t really sell off in a major way. The question hanging over the company is what they’ll do with their surplus cash. A company like BHP has the relative luxury of deciding what to do with its cash flow because it has producing mines generating earnings.

There are plenty of companies, especially in mining, who don’t have that luxury.

Looking for Gold in Cash
 

That’s because they’re not producing anything yet. That means they have nothing to sell and no money coming into the business.

It’s always risky to own shares like these. The payoff is you can make big gains if the company succeeds. But right now this kind of company looks a very dangerous place to be in this market.

That’s why, over at Diggers & Drillers, Alex is switching his focus away from explorers to producers with cash flow or established developers with a tonne of money on the books. He doesn’t want to go near any company that might have to raise money from the market.

He’s on the hunt for ‘little cash boxes’, as he called them, operating very favourable projects. As with BHP, it will be the projects with the lowest construction costs and highest return that will get the funding and the green light,’ Alex told his subscribers this week. Explorers that live or die off drilling results are off the table.

That’s a similar message from Kris Sayce over at Australian Small-Cap Investigator. He’s going after ‘cash box stocks’ because he thinks investors will begin looking at the small end of the market as they hunt for companies that can pay some of their earnings out and offer growth potential at the same time.

In his latest report he says, ‘understand that you should follow what investors do, not what they say…Even though the market mantra is about the search for yield, the reality is different. After a year where ‘safe’ and boring blue-chip income stocks gained 50% or more, investors are getting greedy.

‘That’s why I believe the search for the Holy Grail of stocks – those that can grow and pay a dividend – is the best way to play the stock market during the next phase of this investing cycle.’

In other words, cash is king.

Callum Newman
Editor, Money Weekend

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PS. Don’t forget if you want to keep track of the latest things we’re reading and brief commentary on events that happen through the day, check out our Google+ page and Kris Sayce’s as well.

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Callum is a feature editor for Money Morning. He covers areas of interest arising from world markets and the global economy that could mean new investment opportunities for Aussie investors.

If you're already a subscriber to these publications, or want to follow Callum's financial world view more closely, then we recommend you join him on Google+. It's where he shares investment insight, commentary and ideas that he can't always fit into his regular Money Morning essays.


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