If you were 100% invested in the S&P 500 when that index hit its low point last March and you simply held on, you would have seen an incredible return of around 65% in just about a year. That's an astonishing return for doing nothing more than nothing.
Of course, doing nothing is often easier said than done. At the market's low point, the panic was palpable. We were dealing with a collapsing housing market, crushed investment banks and other financial institutions, and a recession that was already well on its way to being the longest one since the Great Depression.
Staying invested in an environment like that took more than just a little gumption -- it took significant confidence in the companies you were holding.
What it took to persevere
To not pull out what was left of your capital during the market's panicky lows, you had to be certain that the companies you owned would at least survive. The typical questions around how fast they would grow or how much they would earn often took a back seat to that far more primal concern.
And with the debt market in shambles, that survival became a question of balance sheet strength and cash flow. If a company needed to borrow money to make ends meet or even to refinance existing maturing debt, it either couldn't at all or couldn't at anything approaching reasonable rates. That meant that only the most exceptionally strong businesses were able to survive relatively unscathed.
Things may have stabilized a bit since then, but the lessons from that era still remain valid. Indeed, the very characteristics that let the strongest companies survive the downturn are the same ones that will let them thrive as the economy recovers.
And if by some unfortunate event, the recovery never does get to Main Street, those same characteristics that helped them survive the latest crash will help them through the next one, as well.
What corporate strength looks like
Companies set up to survive a mess like the one we've been living through are ones that have -- and had -- their financial houses in order. Key signals of strength include:
- A debt-to-equity ratio below 200%, which indicates the company is not overleveraging itself to try to juice financial returns on minimal business,
- A cash and equivalents-to-current liabilities ratio above 50%, which indicates the company has enough money to cover at least a half-year's worth of its balance-sheet obligations, and
- A free cash flow-to-net income ratio above 90%, which indicates the company is legitimately generating the sort of cash implied by the net income it reports.
When you put that all together, you find companies like these:
|
Company |
Debt to Equity |
Cash and Equivalents to Current Liabilities |
Free Cash Flow to Net Income |
|---|---|---|---|
|
Coca-Cola |
47.8% |
51.2% |
90.8% |
|
Abbott Laboratories |
73.3% |
67.5% |
107.7% |
|
Oracle |
53.6% |
174.8% |
145.2% |
|
Intel |
5.7% |
52.5% |
152.3% |
|
Reynolds American |
68.3% |
62.7% |
136.5% |
|
Fluor |
3.9% |
51.1% |
97.3% |
|
MasterCard |
2.1% |
64.9% |
90.4% |
As you can tell from that eclectic list of names, financial strength can be found in a wide variety of industries. What ties these businesses together, though, is that they've all demonstrated mastery of the cash management side of running a business.
In ordinary times, that's important because it assures they remain disciplined in the expansion opportunities they pursue. Companies with looser cash controls risk grasping at every growth chance they can get, no matter how long the time before the expected payout. Such an undisciplined approach often leads to cases where a business is so expansion-happy that it becomes dependent on being able to roll over its debt at low rates to just survive.
In times of constraints on capital -- our recent experience -- or in times of rising rates -- what we're going into now -- a lack of solid cash management controls can be devastating.
Stay invested in the best
The companies designed and financed with cold, hard cash management in mind are built with the flexibility and strength to survive just about anything the economy can throw at them. By owning companies that are built to survive, you can help yourself maintain the confidence you need to stay invested, no matter how the market performs.
At Motley Fool Inside Value, our unyielding focus on the underlying strength of the companies we've selected enabled us to stay invested, even as the market and the economy tanked. As a result, we've managed to both earn a positive return and stay ahead of the S&P 500 since our launch in 2004.
If you're ready to start building a portfolio based on concepts capable of withstanding the worst economy and market since the Great Depression, join us today. Your 30-day free trial starts when you click here, and there's no obligation to subscribe.
At the time of publication, Fool contributor and Inside Value team member Chuck Saletta owned shares of Intel. Coca-Cola is a Motley Fool Income Investor selection. Intel and Coca-Cola are Inside Value selections. The Fool has created a covered strangle position on Intel. Motley Fool Options has recommended a buy calls position on Intel. The Fool owns shares of Oracle and has a disclosure policy.
