Companies still struggle against an array of economic headwinds: the limited availability of credit, continued deleveraging, and high unemployment, just for starters. Now more than ever, investors must keep an eye on their businesses' financial strength, as reflected by their balance sheets.
Companies you invest in right now -- particularly small ones -- absolutely must have strong cash positions, low or no debt, and/or ensured access to credit. While you're looking for companies that are or will soon begin creating profits, you should also make sure your picks have preserved their capital and better positioned themselves financially for stronger economic growth ahead.
Testing financial strength
There are several ways to test balance sheet strength. Cash has always been king; now, as far as investors are concerned, it's the messiah. A balance sheet can tell you how much cash a company has, and whether that cash position has increased since last year.
You can also measure a company's health by calculating its current ratio (current assets divided by current liabilities), which measures its ability to pay off its short-term obligations. Look for a high ratio of 1 or more here.
Next, study the amount of debt the company carries on its books. The long-term debt-to-equity ratio makes a great place to start. A ratio of 1 would mean that the company's creditors finance $1 for every $1 of equity they receive from stockholders. In this environment, the lower the ratio, the better, since refinancing can be painfully expensive and can increase default rates.
With these guidelines in mind, I sought to uncover companies with strong balance sheets via The Motley Fool's CAPS screening tool. I searched for companies with:
- Current ratios of 1 or greater.
- Long-term debt-to-equity ratios of 1 or less.
- Sterling five-star CAPS ratings.
- Market caps of $250 million or greater.
Here are some companies I pulled from my screen today:
|
Company
|
LT Debt-to-Equity Ratio
|
Market Cap (in billions)
|
Current Ratio
|
|
Airgas
|
0.92
|
$5.2 billion
|
1.6
|
|
American Oriental Bioengineering (NYSE: AOB )
|
0.29
|
$317.2 million
|
3.8
|
|
China Mobile (NYSE: CHL )
|
0.07
|
$199.6 billion
|
1.3
|
|
China Security & Surveillance Technology (NYSE: CSR )
|
0.06
|
$410.9 million
|
1.9
|
|
Johnson & Johnson (NYSE: JNJ )
|
0.16
|
$177.2 billion
|
1.8
|
|
PepsiCo (NYSE: PEP )
|
0.92
|
$105.2 billion
|
1.3
|
|
Schlumberger (NYSE: SLB )
|
0.21
|
$85.2 billion
|
1.9
|
|
Varian Medical Systems (NYSE: VAR )
|
0.02
|
$7.0 billion
|
2.0
|
Data from Motley Fool CAPS. LT = long-term.
Balance-sheet strength is a critical factor when researching companies -- but it's not the only metric worth watching. Investors must remain mindful of the industry in which the company operates, and that industry's growth potential (or lack thereof). Does your company lead within its industry? If not, does it have a product or service that is gaining traction in the market, to help increase its market share? These are just some of the questions you'll need to ask.
Start finding the strongest companies for your portfolio at Motley Fool CAPS today! Let the collective wisdom of our 160,000-member investment community help you make better investing decisions.
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