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When to Worry About Debt Burden

The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.

NEW YORK (MagicDiligence.com) -- Nothing can get a company in trouble faster than excessive debt. Properly utilized, debt can be an excellent way to utilize leverage to magnify the returns of investing retained capital (see this article for a less wonky explanation). So when is debt bad and when is it OK?

To start with, there is a very simple strategy: Consider only stocks for companies that carry no debt whatsoever, or have a miniscule percentage of debt-to-cash (less than 5%, for example). There are hundreds (perhaps thousands) of American companies that satisfy this requirement. In Magic Formula Investing alone there are dozens, even large-caps like Dolby (DLB) and Marvell (MRVL).

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This does tend to limit your investing universe, however. In fact, an odd consequence of great business models is that management is often more willing to run aggressive balance sheets, given the stability of cash flows. Let's look briefly at such a case in MFI: Dish Network (DISH).

The Good Kind

Taking a quick look at Dish's balance sheet, alarms might go off. The company has a negative book value, meaning total obligations are more than assets. Total debt is considerable at $8.5 billion, 185% of cash. Operating profits cover interest obligations at a tight five times over.

However, pay TV is undoubtedly a great business. Churn, the percentage of customers who leave the service in any given period of time, is extremely low, about 1.6%. There are tremendous barriers to entry, considering the costs of building a distribution network, getting FCC licenses, and acquiring content deals. Pricing has remained largely rational, given that only seven companies control the pay TV market in the U.S., allowing for consistent (if small) price increases. Even in 2009, a horrible year for most businesses, Dish suffered no worse than flat revenue growth and a slight margin contraction.

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