Balance Sheets: The Good, the Bad and the In-Between

A 'Work-in-Progress' Balance Sheet

I am very focused on companies with strong balance sheets, but I also look for companies that are working hard to improve their financial status.

When investing, you never want to sacrifice the future to benefit short-term appearances. Management's focus on changing the financial condition of a company will pay long-term benefits to shareholders (see "Talking to Management"). Companies that are paying down debt and accumulating cash and equivalents over time have "work-in-progress" balance sheets.

The benefit of holding cash is far less than the cost of issuing debt. Take a look at MasterCard (MA Quote). MasterCard's long-term debt has declined from about $700 million at the end of fiscal year 2004 to about $230 million at the end of the first quarter of 2007. At the same time, its cash and short-term investments (or marketable securities) balance has gone from $1.2 billion to about $2.6 billion.

Another example of a work-in-progress balance sheet can be found at McDonald's (MCD Quote), which paid off $500 million in debt in 2006 and should pay off at least that much in 2007.

Now, here is your balance sheet homework:

• Review the balance sheets for your stock investments. Determine if you are invested in a company with a strong, weak or work-in-progress balance sheet.
• Look for companies you don't currently own, by scanning for high current ratios, large levels of cash and low levels of debt. Then do some fundamental research on your results. This could identify new investment opportunities.
• Apply balance sheet management to your own financial situation.

(To learn more about balance sheets, check out "Booyah Breakdown: A Blanket View of Balance Sheets" and "Getting Started: The Balance Sheet.")