It's been all implosion, all the time lately, what with the likes of Bank of America
But now is no time to rehash recent history. That damage, after all, has already been done. No, rather than revisiting the ghosts of implosions past, the right question for right now is this: Who's next?
Fill in that blank, and you may be able to dodge a bullet or, if you're feeling aggressive and ambitious, perhaps even profit from a decline by shorting the sucker before the Street picks up on signs of impending doom.
Sign of the times
Those signs aren't particularly difficult to ferret out, either. GM, for example, was having cash-flow woes well in advance of 2008's financial tsunami. Return on equity (ROE) -- a key measure of profitability -- has been moribund at the company as well.
To be sure, GM's stock price has seen the occasional pop, a sporadic phenomenon that should cause savvy types to shrug their shoulders and sigh a healthy, "So what?" It's a company's fiscal health that provides crucial clues to its long-term forward-looking prospects. Stock prices, on the other hand, are subject to the slings and arrows of outrageous market forces, as the past year has made painfully clear.
Doctor, doctor
To my way of thinking, the financial vital signs called out above -- FCF and ROE -- can go a long way toward helping investors separate the living from the soon-to-be corporate dead. And remember: On that latter front, even if bankruptcy or fire-sale acquisition doesn't loom, years of tepid (or worse) performance can take a toll on the portfolios of investors who buy (or hold) companies whose financial statements show them to be in need of defibrillation.
Companies with track records of cranking out plenty of FCF, on the other hand, can resuscitate your portfolio if you acquire them when the price is right. And these days, many of their prices seem to be in Bob Barker, um, Drew Carey territory: Wal-Mart
Tools in the kit
Still, while FCF can be a key indicator of a company's financial health (or lack of it), it's hardly the only tool in an investor's toolkit. Indeed, if FCF is a hammer you can use to bash your way to the bottom line of an investment thesis, return on equity is the equivalent of an adjustable wrench. A subtler but equally valuable tool, ROE reveals just how much profitability bang a company has produced with the bucks its shareholders have on the line.
And here's the bottom line on ROE: If you want to gauge the effectiveness of a management team, the ROE numbers they produce will tell you far more than the conference-call song and dance that the team may give to analysts whenever earnings season rolls around.
As my colleague Rex Moore points out, when it comes to assessing ROE, "higher is better." As with most financial metrics, however, this figure needs to be considered in an industry-specific context. That is, if a company consistently posts anemic ROE numbers and can't compete with its rivals in ROE terms, it may be on its way out of business. As we've seen over the past year, after all, these days, it's frequently the case that only the strong survive.
The Foolish bottom line
As Motley Fool Inside Value advisor Philip Durell recently said, "No financial metric is an island, and ROE is no exception. It should never be used in isolation, but it's a very good first impression of a company's suitability as an investment -- and it might get you closer to more bang for that buck."
It's one of the things he looks for while searching for companies selling with a substantial margin of safety. He also looks for excellent management, great assets, strong cash flow, and competitive advantage. If you'd like to see what he's recommending today, just click here to snag a free 30-day Inside Value guest pass -- there's no obligation to subscribe.
Shannon Zimmerman runs point on the Fool's Ready-Made Millionaire service. At the time of publication, he didn't own any of the securities mentioned above. Johnson & Johnson, JPMorgan Chase, and Bank of America are Motley Fool Income Investor recommendations. Wal-Mart is an Inside Value choice. The Motley Fool owns shares of Proctor & Gamble. You can check out the Fool's strict disclosure policy by clicking right here.
