Is This Company About to Fail?

The credit market remains exceptionally tight these days. In spite of (or perhaps because of) Uncle Sam's help, almost no company that actually needs a loan is able to get one from a private lender at decent rates.

In fact, those that can get money at all are forced to pay outrageous interest for the privilege. General Electric, for instance, is paying Berkshire Hathaway 10% on its preferred shares, and GE had to sweeten the pot with warrants to get its rate that low.

And GE is a profitable industrial titan -- once the world's largest company -- that even after its recent downgrade still sports an impressive AA+ debt rating. When a company like that needs to dilute its shares to get money loaned to it at double-digit rates, you know the credit market is tight.

Although it's difficult and expensive, GE can borrow the cash it needs to operate. But not everyone is so lucky.

Who's at the biggest risk?
In a credit environment this tight, companies that can't either roll over their debt, or pay their debt and operate with what they have, are in danger of going under.

But with the possible exception of law firms that handle bankruptcies, nearly every company is feeling the pain of this economic downturn. So how can you tell if a company is struggling just like everyone else -- or about to fail?

These three signs should make you sit up and take notice:

  • A substantial amount of debt -- given this credit market, a company with significant debt that it can't pay off is a huge risk for shareholders.
  • A negative tangible book value -- which means that its total worth is tied up in its brands, its goodwill, and its ability to generate cash, leaving nothing to borrow against.
  • Negative earnings -- which means that it hasn't recently been able to run its business profitably. If that condition doesn't change, those debt holders will soon tire of financing the company's operations.

When you put all three of those high-risk signs together, you get companies like these:

Company

Tangible Book Value

TTM Net Income

Total Debt

Boston Scientific (NYSE: BSX  )

($6,263)

($2,371)

$6,247

Genworth (NYSE: GNW  )

($981)

($572)

$9,585

Sara Lee (NYSE: SLE  )

($617)

($248)

$2,812

Cablevision (NYSE: CVC  )

($8,753)

($228)

$11,990

Delta Air Lines (NYSE: DAL  )

($14,128)

($3,326)

$16,596

Expedia (Nasdaq: EXPE  )

($2,166)

($2,518)

$1,545

Advanced Micro Devices (NYSE: AMD  )

($636)

($3,142)

$5,697

All numbers in millions. Data from Capital IQ, a division of Standard & Poor's.

Of course, not every company that shares these traits is on the verge of failure, and I'm not suggesting that the above companies are literally about to fail. Just looking at two examples, Sara Lee and Boston Scientific are showing the aftereffects of non-cash goodwill writedowns. While a sign of overoptimistic expansion plans gone astray, it's not exactly a corporate death sentence.

On the other hand, those three signs in combination often tell of darker days to come. Indeed, Delta has already suffered through a bankruptcy, and recently a competitor of Cablevision (Charter Communications) with precarious financials filed as well.

If a company is in debt, doesn't have enough assets to borrow against, and it isn't generating cash, then it's really only a matter of time before its debt holders get tired of financing its business. That's especially true now.

Buy smarter
In general, companies that hemorrhage cash, have weak balance sheets, and are drowning in debt make lousy investments. On the flip side, those that gush cash, are smart with their use of debt, and have solid balance sheets backing up their businesses can be tremendous companies to own.

That's especially true during times like these when virtually every company has been knocked down off its peak, and even the strongest ones are available at bargain-basement prices.

At Motley Fool Inside Value, we're actively scouring the market to find the solid companies whose shares have been left to rot alongside the truly damaged ones. When we find those diamonds in the rough, we share them with our members, who then have the opportunity to buy some of the world's greatest companies at bargain prices.

If you're ready to avoid the companies teetering on the edge of failure, and instead focus on those with the fundamental strength to thrive in the long run, then join us at Inside Value. Simply click here to learn more or start your 30-day free trial.

This article was originally published March 8, 2009. It has been updated.

At the time of publication, Fool contributor and Inside Value team member Chuck Saletta owned shares of General Electric. The Motley Fool owns shares of Berkshire Hathaway, which is both a Motley Fool Stock Advisor selection and an Inside Value pick. The Fool has a disclosure policy.


Read/Post Comments (7) | Recommend This Article (19)

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 May 12, 2009, at 2:12 PM, vtkev02 wrote:

    The Motley Fool... what a joke....

    Genworth has plenty of cash (reference an article from it's hometown newspaper, The Richmond Times-Dispatch that came out on May 10th).

    http://www.timesdispatch.com/rtd/business/local/article/GENW...

  • Report this Comment On May 12, 2009, at 2:51 PM, kurtdabear wrote:

    In its last fiscal year SLE paid more than $200 million in income taxes, raised its dividend and reduced debt. It could not have done that if it was losing cash.

    It's in the midst of a long-time, well-publicized restructuring plan. As a result, it's subject to reporting various non-cash "charges," i.e., write-downs in goodwill on discontinued businesses, severance obligations, facilities closing charges, etc.

    Don't rely on simple stock analysis programs that just pass raw numbers through a computer to rate a stock. Using an S&P report or some similar detailed analysis that's actually reviewed and written by human beings will give you a truer picture of a company. The Motley Fool's own statistical analysis for SLE shows that it had "normalized" earnings last fiscal year of $1.28.

  • Report this Comment On May 12, 2009, at 3:11 PM, tedhunt1 wrote:

    Motley Fools they are...I purchased AIB and FR as two "best of best" recommendations of MF...applying similar principals...MF knows nothing except how to market their poor advice.

  • Report this Comment On May 12, 2009, at 6:30 PM, DesktopPC wrote:

    This was the worst article I have ever read form Motley Fool and I have read many bad ones.

    You have done zero in terms of research and just scanned some headlines to draw conclusions.

    Good thing you do not do this for a living.

    Please do not do us any more favors and please burn all your articles.

    By the way you can only claim $3,000 in loss tax losses per year you had better live to a hundred!

  • Report this Comment On May 12, 2009, at 11:38 PM, sensible1 wrote:

    Genworths claimed assets are misleading as they are the cash they are holding for their policy holders.

    Spinning off a company , which they intend to do, to raise capital diminishes the value of the company which is already in trouble.

    Genworths biggest asset is that the gov't has pledged to not allow a life insurance co. to fail and screw its policy holders. Doesn't mean stock holders are the ones not to lose.

  • Report this Comment On May 13, 2009, at 7:43 AM, mjr53 wrote:

    Are you kidding me? This is your idea of advice? We should all buy strong companies and not but the weak ones. Pure genius! Brilliant thinking! Who'd have ever figured that one out? Thank goodness for people with as much market savvy as you because the rest of us would just be lost without your razor-sharp insight. But you're correct about one thing: Let's all "Buy Smarter" by not buying your weak advice.

  • Report this Comment On May 13, 2009, at 4:07 PM, bobbyzz wrote:

    GNW has a tangible book value in excess of $15.00 per share. They have cash on hand to cover all debt comming due this year and no maturities till 2011.

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