Debt and fiscal responsibility -- or the lack thereof -- have become hot topics of conversation for many Americans. Standard & Poor's downgraded the U.S. government's debt rating last weekend, sparking anxiety, panic, and a volatile marketplace.
Unfortunately, fearful investors and eager bargain hunters may be racing out of or into today's stock bloodbath for all the wrong reasons -- and ignoring a key metric that could determine whether those investments stumble or soar.
Debt dangers
The 2008 financial crisis should have clarified the perils of large-scale indebtedness. Years of haphazard lending to consumers who couldn't pay back their mortgage obligations helped drag big banks and mortgage lenders into the crisis, with our whole economy following close behind.
Some critics blame profligate consumers who spent beyond their means; others accuse the financial companies that let them do it. But American consumers aren't alone in this kind of rash spending. It's become a part of our entire national culture.
The U.S. government is now more than $14 trillion in debt, thanks to a combination of deficit spending and lackluster tax revenues. The S&P's downgrade of our national credit rating may have been unwelcome news to many people, but it's just the tip of the "reality check" iceberg. There are ample signs that the U.S. economy's "recovery" was little more than a daydream, prompting a fragile and irrational period of bullishness in stocks.
Now that the daydream's over, the market's choking. But while calm, long-term investors should set their sights on bargain shopping now, they must also avoid companies that didn't clean up their balance sheets over the last several years.
Junk and junkies
Unfortunately, the financial crisis wasn't enough to sober up either speculative investors or debt-burdened companies.
Believe it or not, for the past year or so, junk bonds have been one of the hottest assets around. These high-yield bonds have a good reason for offering such a high potential return: They carry an equally high risk of default. Now that our economic outlook is clearly deteriorating, investors are finally fleeing junk. But their previous willingness to speculate on such dicey bets shows that many never learned from the financial crisis.
Businesses with tons of debt, crumbling fundamentals, or emerging threats to their future growth can poison portfolios, especially in a lousy economy that makes survival harder for every company. Let's glance at a few examples.
Cedar Fair's (NYSE: FUN) debt-to-capital ratio is a whopping 96.8%. In the last 12 months, it has reported a loss of $1.22 per share. Although revenue increased 6% in that time, a grimmer economic outlook could certainly make life a lot more difficult for this company and its investors.
United Rentals (NYSE: URI) has hit the skids, having reported annual losses from 2008 through 2010. Although it's managed to squeak out a profit of $0.12 per share in the last 12 months, can it deliver the growth analysts expect this year given accelerating economic weakness? Investors should also consider that its total debt-to-capital ratio is 99.2%.
Cablevision (NYSE: CVC) recently spun off AMC Networks (Nasdaq: AMCX), the network behind popular programming like Mad Men. But the company's balance sheet looks more like The Walking Dead. AMC Networks' debt-to-capital ratio is 92.8%, and it took on $2.43 billion in new debt after the June 30 spinoff.
Investors should think long and hard about which stocks they snap up in the market's current turmoil. Plenty of stocks have enough of a cash cushion to stave off debilitating debt dilemmas.
Apple's (Nasdaq: AAPL) been making headlines after its brief victory in overtaking ExxonMobil's (NYSE: XOM) market cap yesterday. Apple's ability to generate shocking growth in a nasty economic climate is great, but the iEmpire has an even bigger ace up its sleeve. It holds $28.4 billion in cash and short-term securities -- about $30 per share -- and no debt.
The many faces of responsibility
I usually focus on social responsibility in this column, but fiscal responsibility matters, too. In times like these, it's more essential than ever. Managers who've racked up years of strangling debt endanger shareholder returns and their own future profitability.
As long as we've all got debt on our minds, let's all weigh how responsible bargain stocks' balance sheets are before we buy into them. The best bargain stocks out there are leadership names with stable businesses and clean balance sheets -- all the better to weather the current economic storm.
Check back at Fool.com every Wednesday and Friday for Alyce Lomax's columns on environmental, social, and governance issues.
