It's clear from the volatile first few weeks of 2022 that investors are concerned about inflationary pressures in the economy and the Federal Reserve's plans to raise interest rates three times this year to combat it. This matters because rising rates signal that the Fed's easy monetary policies are winding down. It also means companies with high debt levels will face higher interest rates in the future when they refinance or issue more debt. As a result, the stocks that get hit first are those with high valuations that may not turn a profit for a while.
Paying attention to a company's balance sheet lets you know if a company is on a solid foundation -- or not -- and can tell you how resilient it can be in different market environments. For this reason, you want to seek out companies with strong balance sheets. Two companies with fortress balance sheets that can fortify your portfolio are Berkshire Hathaway (BRK.A 0.55%) and Visa (V 0.73%).
1. Berkshire Hathaway
Berkshire Hathaway sits atop the list when it comes to fortress balance sheets. Warren Buffett has an established history of outperformance as Berkshire's chief executive, and a big reason is that the company manages its balance sheet so well.
One essential part of having a resilient balance sheet is holding a large amount of cash (and cash equivalents) relative to total debt. Through the end of the third quarter of 2021, Berkshire Hathaway was sitting on its largest cash pile in history -- $150 billion.
With a large amount of cash on hand, Berkshire Hathaway can play both offense and defense. If an economic downturn slashed stocks' valuations, Berkshire and Buffett are ready to pounce. Not only that, but having a giant pile of cash on hand gives the firm flexibility to make acquisitions or buy back more stock.
Debt-to-equity ratio is a metric that can show you how much leverage a company uses. A high ratio means a company uses a lot of leverage to run its business, and it could be a sign of higher risk. A ratio of 2 or more might indicate that a company is taking on too much debt to fund its growth efforts. A lower ratio of 1 or less is ideal because it means a company is using less debt and more of its own funds to finance operations. Berkshire Hathaway sports a slight debt-to-equity ratio of 0.24, which is on the low end for the company over the past 10 years.
Berkshire Hathaway stock has underperformed the S&P 500 over the past five years. However, Buffett has a history of beating the market over more extended periods, and the reason is because he's so patient when putting his cash to work.
Even with such a massive cash pile, Berkshire Hathaway's current investments are positioned to do well in an inflationary and rising interest rate environment. And if that drags down valuations on stocks, Buffett stands ready to take advantage.
It shouldn't be a surprise that this next company on the list is also a Warren Buffett holding: Visa. The global payments company boasts a strong balance sheet, with $14 billion in cash and cash equivalents through the end of 2021.
One reason Visa has so much flexibility is its free cash flow: It produced $15 billion in 2021. Free cash flow is a metric that shows you how much cash remains after a company pays operating expenses and capital expenditures (like purchases of property or equipment). A company with lots of free cash flow might have an easier time paying its debt and making dividend payments; a negative measure could be a red flag.
Visa has nearly $18 billion in long-term debt obligations but currently sports a modest debt-to-equity ratio of 0.58, suggesting it isn't using excessive leverage to fund its business.
Sitting on a ton of cash puts companies in a great position to invest back into the business. For example, in 2020, Visa had announced it would acquire Plaid, a company that connects financial institutions with consumer financial apps, for just over $5 billion. This would've been a match made in heaven if regulators hadn't scrapped the deal. Visa wasn't deterred and put $2 billion into acquiring a Swedish fintech start-up called Tink. While this wasn't the deal the company had initially hoped for, it should help Visa continue to push into the open-banking movement.
This is the advantage of having a strong balance sheet. Well-run companies like Visa that generate high amounts of cash can put that to work -- making huge acquisitions that propel their next phase of growth.