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6

IBM's Debt: Disaster, or No Big Deal?

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Debt isn't always a bad thing. Sure, too many Americans have gone crazy with credit cards and home equity loans, severely endangering their financial futures. But the debts that put us through college or help us buy a home can be far more useful. Similarly, companies that go into debt aren't always in bad shape. Their well-being depends largely on whether they can afford the debt they've piled up.

Many investors seeking compelling companies often shun those carrying debt. Look at IBM (NYSE: IBM  ) . As of the end of September, it had $20.6 billion in long-term debt and almost $5 billion in short-term debt, against just $18.4 billion in shareholder equity, for a long-term debt-to-equity ratio of 1.12. That's enough to drive many cautious investors away.

Like IBM, these companies also sport debt-to-equity ratios greater than 1 -- but they've nonetheless earned top ratings from our Motley Fool CAPS community:

Company

CAPS rating (out of 5)

LT Debt-to-equity

International Game Technology (NYSE: IGT  )

****

2.24

Deere (NYSE: DE  )

****

2.25

Lockheed Martin (NYSE: LMT  )

****

1.13

GlaxoSmithKline (NYSE: GSK  )

*****

1.62

Colgate-Palmolive (NYSE: CL  )

****

1.04

DuPont (NYSE: DD  )

****

1.02

Data: Motley Fool CAPS.

Why the love from CAPS, given their high debt? For starters, you need to understand that all debt is not alike.

The good, the bad, and the borrowed
Like many companies, IBM details its debt obligations in its annual report. Among other factoids I unearthed:

  • Its short-term debt at the end of December 2008 bore weighted-average interest rates of 3.1% (for commercial paper) and 4.5% (for short-term loans).
  • Its long-term fixed-rate debt averaged 6.16%, while its floating-rate debt averaged 3.35%.

OK, so IBM's not amassing insanely high interest on its debts. That's a good start. Next question: How easily can the company repay its debt? Its third-quarter results give us the answers:

  • The company earned $3.2 billion in net income, up 14% from last year.
    Free cash flow was $3.4 billion.
  • The company had a cash balance of $11.5 billion.
  • The interest on IBM's debt totaled $512 million over the past 12 months.

In short, IBM is making enough cash each year to easily cover the interest on its debt and pay down the principal. And even if it generates less cash in the future, it's got a hefty stockpile stashed away to make up for any shortfall.

Yes, you should be wary of debt-laden companies … but only if a closer look reveals that they can't pay back what they owe. When deployed effectively -- to buy back shares at a steep discount, or to invest in projects that will expand and improve the business, among other examples -- debt can genuinely help companies and their investors alike.

Longtime Fool contributor Selena Maranjian owns shares of International Game Technology. Try any of our investing newsletters free for 30 days. The Motley Fool is Fools writing for Fools.


Read/Post Comments (4) | Recommend This Article (6)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On December 16, 2009, at 5:44 PM, rufianno wrote:

    $20.6 billion in long-term debt and almost $5 billion in short-term debt-against just $18.4 billion in shareholder equity, for a long-term debt-to-equity ratio of 1.12.THEY ARE NOT RUNNING THIS COMPANY FOR ITS SHAREHOLDERS.THAT'S WHY I LOVE INDEX FUNDS AND EXCHANGE TRADE FUNDS.

  • Report this Comment On December 16, 2009, at 7:14 PM, Fool wrote:

    If you are that concerned about IBM's debt (and assuming that you have more than $2,000 worth of IBM stock held for more than 1 year), you could introduce a stockholder proposal to eliminate (or significantly reduce) the debt - say, require the company to keep its debt/equity ratio less than 1.

  • Report this Comment On December 16, 2009, at 8:55 PM, funfundvierzig wrote:

    The critical debt/equity ratio for the much shrunken and troubled DuPont Company may get worse before it gets better. For the latest reported 12-month period, Sept. 30, 2008 through Sept. 30, 2009, total stockholders' equity plummeted dramatically by over $5 billion, from $12.7 billion to $7.6 billion.

    If there are additional borrowings of long-term debt and/or additional pension charges or write-offs for certain declining businesses or assets, this key metric of financial health could deteriorate further for the anemic DuPont Company.

    ...funfun..

  • Report this Comment On January 01, 2010, at 7:22 AM, Funfunchaser wrote:

    banned, canned, and unemployed....

    who is listening?

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Selena Maranjian
TMFSelena

Selena Maranjian has been writing for the Fool since 1996 and covers basic investing and personal finance topics. She also prepares the Fool's syndicated newspaper column and has written or co-written a number of Fool books. For more financial and non-financial fare (as well as silly things), follow her on Twitter...

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