Every day seems to bring news of another company with shaky finances.
On July 15, it was General Motors (GM) trying to mend a broken balance sheet. The automaker is cutting costs and canceling its dividend as part of efforts to raise a much needed $15 billion.
And this is a particularly difficult time to be cash-hungry. A year into the credit crisis, lenders are reluctant to lend to anyone, whether a company or a home buyer, with a shaky credit profile.
In recent years, "it was pretty easy to get a loan," says Sam Stewart, chief executive and chief investment officer of Wasatch Advisors. That's changed. "If you're dependent on outside financing, you've got to review the playbook," he says.
BusinessWeek asked investing experts for tips on how to avoid stocks with weak finances, and how to choose strong companies at a time when strength seems especially valuable.
1. Look for lots of cash and low levels of debt.
There are different ways to crunch the numbers, but expert investors agree on the importance of diving into the data. Look at how much debt is on the balance sheet, with short-term debt the riskiest. Look at how much cash the firm has. Compare cash and debt levels to rivals in the same industry. Another key measure many investors use is free cash flow, a determination of, when all is added up, whether more money is flowing into the firm than out in a given quarter.
Companies with little debt and lots of cash have big advantages in an environment like this.
"When they hit hard times, they have cash to tide them over," says Scott Armiger of Christiana Bank & Trust. He points to USG (USG), a building materials company hurt by the housing slowdown (BusinessWeek.com, 6/18/08) but still modernizing its factories.
A healthy balance sheet also allows firms to make acquisitions when market valuations are low. "Strenuous times [are] when they go shopping, because they see businesses on sale," Armiger says.
Many weaker firms borrow heavily to finance acquisitions. "Debt can allow you to grow, but it can create a lot of problems in a downcycle," says Ken Hemauer, director of research at Baird Investment Management.
Companies can be crippled by high debt burdens. Rob Lutts of Cabot Money Management points to the debt-laden auto and airline industries. "If they didn't have the debt, they could adjust their business operations and succeed," he says. Exxon Mobil (XOM), however, manages to operate in a capital-intensive business with almost no debt, Lutts says.
2. Other financial measures.
Cash and debt levels are at the top of most lists, but investors also include other criteria.
Lutts looks for "very high" aftertax profit margins, often of 25% to 30%. "It brings more strength to a company on a daily basis," Lutts says, citing Google (GOOG) and the Chinese firm New Oriental Education (EDU) as examples.
Mustafa Sagun, chief investment officer of Principal Global Investors' equities group, emphasizes not just good fundamentals, but improvements in those measures, such as increasing revenue, widening profit margins, and rising profits.
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