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Stock Strategist

Five Stocks to Buy When Cash Is King

Strong balance sheets will anchor these companies in times of turmoil.

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The headlines are everywhere: banks are dead; consumers are dead; Congress is useless; houses are less than useless; even the redoubtable growth engines of Asia are wheezing to a halt. In this dark and uncertain environment, it's tempting to sell all your stocks and wait for better days.

While we are sympathetic to such views and think it's wise to exercise caution, it's probably not smart to exit the market in a panic. Very few people can time markets consistently, and there is an ample body of research showing the folly of attempting to do so. Fortunately, there are ways of protecting yourself without going to cash, such as investing in companies with solid balance sheets and little liquidity risk--companies that can take advantage of this recession by buying distressed rivals or expanding their businesses and taking market share. These businesses should exit the recession bruised, but leaner and tougher than ever before.

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.

Here are a few companies we uncovered with this screen worth a further look:

Jacobs Engineering Group
Moat Rating: Narrow | Fair Value Uncertainty Rating: Medium| Morningstar Rating: 5 Stars
From the Analyst Report: " Jacobs Engineering (JEC) is a highly regarded player in the cyclical and highly competitive engineering and construction industry. Through many cycles, Jacobs has been able to deliver relatively consistent financial performance and healthy returns, which we attribute to complementary key strengths--its long-term customer relationships and its process-management capabilities."

Moat Rating: Narrow| Fair Value Uncertainty Rating: Medium| Morningstar Rating: 5 Stars
From the Analyst Report: " Administaff  (ASF) is the largest stand-alone professional employer organization, a company that provides human resources services for small businesses. In our opinion, high switching costs and solid profitability earn this firm a narrow economic moat."

ExxonMobil Corporation
Moat Rating: Wide| Fair Value Uncertainty Rating: Low| Morningstar Rating: 5 Stars
From the Analyst Report: " ExxonMobil  (XOM) led the industry with record profits as commodity prices soared, but the real value comes from the company's operational excellence, which drove performance and distinguished the company from its peers... We believe no other supermajor integrated energy company is better-suited for the current environment than Exxon."

Novellus Systems
Moat Rating: Narrow | Fair Value Uncertainty Rating: Medium | Morningstar Rating: 5 Stars
From the Analyst Report: " Novellus Systems (NVLS) is a leader in its segment of the chip-equipment market. The firm is positioned to gain from advances in semiconductor fabrication technology but faces some tough competition... Within its complex field, the firm has maintained its strong technological position with large research-and-development expenditures, which total more than $200 million per year, and it has rolled out some of the most productive systems on the market. Also, the firm has achieved an effective cost structure through outsourcing the majority of its manufacturing."

Novo Nordisk  
Moat Rating: Wide | Fair Value Uncertainty Rating: Medium | Morningstar Rating: 5 Stars
From the Analyst Report: " Novo Nordisk's (NVO) prowess in developing and marketing diabetes treatments endows the company with a wide economic moat, in our opinion. Although competitive pressures are intensifying, we expect new products, a relative lack of patent exposure, and market growth to enable Novo to continue to thrive... [it] is the world's premier diabetes drugmaker. It has a 52% share of the worldwide insulin market, and is the number-one provider of modern insulin, such as long-lasting Levemir and quick-acting NovoRapid."

To run this screen and see all the stocks that passed,  click here. Note: The stocks mentioned above passed our screen as of Oct 1, 2008. The results of the screen may change because of daily price fluctuations or other factors. After clicking, you can save the search to use later by clicking the Save Criteria button in the bottom right-hand corner of the screen. (You will need to be logged in as a Premium Member to view and save the complete screen.)

Michael Tian does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.