The Leverage Isn't Where You Think

$2.16 trillion -- that's the aggregate amount of net debt on the balance sheets of the companies in the S&P 500 (ex-financials) at the end of 2008. Surely these companies have been following the banks' lead and reducing their leverage now that the great credit banquet has come to a tumultuous close. Right?

Think again: The figure hasn't moved from its level at the end of the second quarter of 2008. In fact, at the end of the second quarter of 2007 -- arguably the peak of the credit boom -- aggregate net debt was lower than it is now:

*Earnings before interest, taxes, depreciation, and amortization (EBITDA) is a measure of the firm's operating cash flow.
Sources: Capital IQ, author's calculations.

Debt levels are stable and manageable
The preceding table highlights two things: First, debt ratios for this group of companies have remained remarkably stable throughout the credit crisis. Second, debt levels appear to be quite manageable. This suggests that this group of relatively high-quality companies isn't suffering from a debt hangover and that the problem lies with marginal borrowers and companies that were taken private in LBOs at the height of the credit-fueled LBO boom. (In 2007, LBO groups were saddling their targets with total debt of more than five times EBITDA.)

Bear in mind, however, that there are important variations in leverage within the S&P 500, as the following table demonstrates:

Source: Capital IQ.

Companies with little or no debt are always more flexible than their leveraged peers, but that difference is vital in an environment that combines a credit crisis and a severe recession. Those conditions favor investors who remain invested in or migrate toward companies with an unencumbered balance sheet -- take stock!

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