Editor's note: In the last two quarterly earnings seasons, Scott Rothbort graded several corporate balance sheets:
"Balance Sheets 101: Who Made the Grade" (Spring 2008)
"Balance Sheets 101: Who Made the Grade" (Summer 2008)
As the current earnings season starts to wind down, Rothbort evaluates a new set of balance sheets, and few new metrics.
We are in the middle of one of the worst credit crises in the history of corporate America. That said, let's examine the financial qualities to look for in companies that have the potential to survive the current "crunch."
Net Cash and Enterprise Value
With so much focus lately on which companies have too much debt, I suggest we need to look in the other direction: Companies that are flush with cash and have little or no debt. In particular, I was struck by
recent earnings announcement and conference call. (Don't miss "
TheStreet.com TV: Apple Call Shocker: Jobs Talks Surplus (Video, Oct. 23)
Gary Krakow and James Rogers dissect the finer points of Apple's earnings call and Steve Jobs' remarks about iPhone sales, the competition and an abundance of cash.
To watch the video, click the player below:
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On top of the company announcing superb operating results, a highlight of Apple's recent quarter was the company's ability to generate even more cash and compile a healthy balance of cash and short-tem investments (taken together as "cash") of $24.5 billion. This equates to $27 per share in cash. With a current stock price of around $107 per share, nearly 24% of Apple's
is represented by its cash.
Now let's find other companies with strong Apple-like balance sheets.
service, I performed a scan of American companies that fit the following four criteria:
Cash in excess of $1 billion
Marketable securities in excess of $1 million
Total debt less than $1 billion
Market cap in excess of $1 billion
(Note: I downloaded the data in the middle of yesterday's trading session.
separated cash from marketable securities. Thus, I set a low balance for marketable securities in order to capture that data in the analysis.)
Next, I performed a few mathematical functions:
Added cash to marketable securities and subtracted total debt (which I define as "net cash")
Divided the result above by market capitalization (percentage of net cash of market cap)
Sorted the database by the net cash percentage of market cap
The results of this analysis are displayed in the table below:
Odyssey Re: Holdings
has net cash equal to 2.3 times the market cap of the company. In essence, the company has more net cash than the market is valuing its stock. This leads me to the concept of enterprise value.
Enterprise value is the market capitalization of a public company
its debt. This represents the true cost of buying a company if done at market value. So in the case of
, the enterprise value would be equal to $7.85 billion, which is approximately $2 billion less than its market cap.
Balance Sheet Strength: The Z-Score
When earning my MBA, I had the privilege of being taught by Professor Edward Altman at the New York University Stern School of Business. In
Corporate Financial Distress: A Complete Guide to Predicting, Avoiding and Dealing With Bankruptcy
, Prof. Altman describes his concept of the discriminate "Z-Score."
The z-score is a quantitative model that analyzes various balance sheet measures to separate the "healthy" companies from the "sick" ones. Simply put, the higher the z-score, the healthier the company. As Tim Melvin wrote in "
," a z-score above 3 indicates that the company is healthy and in no danger of bankruptcy. A z-score below 1.8 is a prediction of imminent collapse.
I went back to
and obtained z-scores for all of the companies that were presented in the search data I identified earlier.
Please note that z-scores are not calculated for financial companies (since debt is a big of the part of the financial business) and thus
were excluded in the table below:
All of the companies from the search yielded high z-scores, with the exception of
Clearly many of these cash-rich low-debt companies have strong balance sheets and may be excellent investment opportunities.
As a point of reference, I thought that I would point out some companies with low-z-scores. In "
How to Spot the Worst-Managed Companies
," I identified three companies that have really lost their way. Here are their z-scores:
General Motors : -0.07
Time Warner : -0.14
The empirical z-scores seem to confirm my opinion that all three of these companies are in critical financial condition.
Using the tables in this article, identify worthwhile investment opportunities based on one or more of the criteria presented.
Research a few smaller companies with large percentages of cash and a high z-score. (Note: Bloomberg Professional access can be costly, so for more on the z-score, consider picking up a copy of Altman's book.)
At the time of publication, Rothbort was long AAPL and GOOG, although positions can change at any time.
Scott Rothbort has over 20 years of experience in the financial services industry. In 2002, Rothbort founded LakeView Asset Management, LLC, a registered investment advisor based in Millburn, N.J., which offers customized individually managed separate accounts, including proprietary long/short strategies to its high net worth clientele.
Immediately prior to that, Rothbort worked at Merrill Lynch for 10 years, where he was instrumental in building the global equity derivative business and managed the global equity swap business from its inception. Rothbort previously held international assignments in Tokyo, Hong Kong and London while working for Morgan Stanley and County NatWest Securities.
Rothbort holds an MBA in finance and international business from the Stern School of Business of New York University and a BS in economics and accounting from the Wharton School of Business of the University of Pennsylvania. He is a Term Professor of Finance and the Chief Market Strategist for the Stillman School of Business of Seton Hall University.
For more information about Scott Rothbort and LakeView Asset Management, LLC, visit the company's Web site at
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