Five Stocks to Buy When Cash Is King

We devised a simple screen to root out these firms:

1. Morningstar Rating of 5 stars
2. Debt/Total Capitalization ratio of less than 10% in the most recent year

We think these criteria are self-explanatory. However, in this environment, this screen may uncover a large number of candidates (56 as of Oct. 1, 2008). The art is in deciding which companies to research further. It's difficult to quantitatively screen for these other characteristics, but we'll do our best to outline a few ways in this article. It may require a little work, but the signs are easy to follow, even for relatively inexperienced investors.

For example, it's helpful if the company has a large healthy net cash balance. In today's world, the definition of cash can be hazy. Earlier this year, due to turmoil in the municipal and auction-rate securities markets, many companies took surprise losses on these supposedly solid cash-equivalent instruments. An investor would do well to scrutinize the balance sheet and footnotes carefully, making sure there are no similar land mines.

Furthermore, it's a positive sign if the company is the most powerful player in its industry. There are many easily discernable signposts here. Our premium members can gain access to a list of a firm's competitors in our Analyst Reports. This will shed light on several questions: Does the firm consistently earn superior margins and returns on assets or equity versus its competitors'? Or even better, does the firm have the most competitive advantages in its industry? Having a moat is important--it increases the chance that the company's rivals will be more distressed, thereby opening windows of opportunity.

Last, the company may have a history of taking advantage of downturns. Many giants today took advantage of recessions to snap up assets on the cheap. It may be helpful to look back on how the firm behaved during the last business cycle. Take note if it bought rivals, invested in production capacity when costs were low, or bought back significant chunks of stock cheaply, allowing earnings to multiply when the tide turned.