You Have More Brains Than Wall Street

In the 1939 classic The Wizard of Oz, there's a great scene in which the scarecrow asks the Wizard for a brain. The Wizard retorts:

Back where I come from, we have universities, seats of great learning, where men go to become great thinkers. And when they come out, they think deep thoughts -- and with no more brains than you have. … But! They have one thing you haven't got! A diploma!

As banking's troubles continue to get worse, the truth behind the Wizard's words has seemingly never been more apparent. Ordinary banking has to be one of the simplest, most profitable businesses around. It's only when you overcomplicate it to try to squeeze out every last penny that you really start running into trouble.

Yet how many banks are turning to international capital markets for a bailout because their plans went awry? How much long-term damage might the Federal Reserve be inflicting in its attempt to hold together the banks that got themselves in trouble? All of this panic began largely because housing was off by a mere 8.4%.

The benefits of simplicity
Back before the invention of the hyper-complex mortgage-backed securities that enabled the meltdown, people used to have to come up with down payments for their mortgages. It was standard practice for banks to require 20% down. If you didn't have the cash, you either rented, took out private mortgage insurance, or purchased a piggyback second mortgage at far higher interest rates.

The advent of those mortgage-backed securities allowed many lenders to ignore the risks that had led to such commonsense requirements in the first place. (And make no mistake -- down payments are commonsense requirements.) The industry had forgotten that assets, including the homes that backed up those securities, could go down as well as up in value. Talk about overeducated, empty suits with more diplomas than brains!

Back to basics
Unfortunately, the banking meltdown spread throughout the rest of the economy. As banks now tighten up their standards, it becomes tougher and more expensive for both individuals and businesses to borrow. That slows down economic expansion and hits the fastest-growing, not-yet-self-sufficient companies the hardest.

In times like this, the only companies worth owning are those that can take care of themselves. Those, like the ones in the table below, are the companies with strong balance sheets, good cash flows, and the pre-existing financial discipline that's enforced by healthy dividends. And they are the most likely to shine.

Data as of May 27, courtesy Capital IQ, a division of Standard & Poor's.
*Earnings before interest and taxes.

Since these companies can easily cover their near-term liabilities with their current assets, they're not trapped by the current liquidity crisis. And since they all can cover their interest payments several times over, even if rates soar as banks scale back their lending plans, they'll be able to cover their debt-service costs. To support their healthy dividend yields, they've already instituted the same sort of financial controls and discipline that will serve them well throughout this crisis. And with strong cash flows -- often stronger than their earnings would suggest -- their operations pay for themselves. That reduces their need to tap into the faltering credit markets at all.

Profit from the panic
It's fundamentally strong companies like these that will best survive this downturn and will be best positioned to take advantage of their financially weaker competition. Only the strongest survive a meltdown largely unscathed and ready to conquer during the subsequent recovery. Those are the types of companies you should be looking to add to your portfolio. If you need a few ideas, our Motley Fool Inside Value lineup of stock recommendations features some strong companies trading at dream prices. If you're interested in reading about our top stock ideas, we offer a free 30-day trial.

At the time of publication, Fool contributor Chuck Saletta owned shares of Sysco. Eli Lilly and Sysco are Motley Fool Income Investor recommendations. The Fool's disclosure policy has more heart than the Tin Man and more courage than the Cowardly Lion.