Gathering economic clouds point toward a second recession. Fortunately, investors can insulate their portfolios from this storm by investing in companies with recession-proof balance sheets. Here, we'll look at four such companies, and break down their balance sheets into two key components worth watching.
The cash component
Although it probably goes without saying, the more cash a company has going into a recession, the better. Witness the unprecedented cash hoards of Apple
Source: Yahoo! Finance.
At a bare minimum, a company should have at least enough cash or cash equivalents on hand to pay off all of its current liabilities -- a principle known as liquidity.
The most common measures of liquidity are the current and quick ratios. The current ratio divides a company's current assets (things like cash and inventory) by its current liabilities (expenses like salaries and rent). The quick ratio, on the other hand, simply excludes inventory from the preceding calculation because it isn't as easily convertible into cash. In either case, we want to see ratios higher than 1.
Not surprisingly, all of the companies from the preceding chart have more cash than necessary to cover their current liabilities. And if you include long-term investments, some of them have more than 10 times the amount they need!
The debt component
Debt is the yin to cash's yang going into a potential recession. It becomes exceedingly expensive to service as revenues decline, and it reduces borrowing power at the worst possible time.
In fairness, debt can be an unquestionably attractive and often necessary component of a well-managed balance sheet. Companies like Coca-Cola
As a result, you want to invest in companies with an appropriate amount of debt for their business. Enter the debt-to-equity ratio, which compares the amount a company owes to the amount it's actually worth.
If you convert this ratio into a percentage, you can relate it to concepts familiar to us as homeowners. Microsoft's debt equals to 21% of its equity. Intel and Google's debt, on the other hand, equals less than 4% and 8% of their respective equities. And Apple doesn't even register, because it has no debt whatsoever!
It's better to be safe than sorry
The exercises above show the financial strength of some of today's premier technology companies. Their large amounts of cash will help them better weather any financial storms that might be brewing. With the sector trading at its lowest P/E multiples in decades, investors seeking safety may want look into tech.
The Motley Fool owns shares of Google, Coca-Cola, Apple, and Microsoft. The Fool owns shares of and has bought calls on Intel. Motley Fool newsletter serviceshave recommended buying shares of McDonald's, Microsoft, Google, Apple, Intel, and Coca-Cola; creating bull call spread positions in Apple and Microsoft; and creating a diagonal call position in Intel. Try any of our Foolish newsletter services free for 30 days.
Fool contributor John Maxfield does not own shares in any of these companies mentioned in this article. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.