"Banks worldwide are hoarding cash in the face of weakening balance sheets, bank failures and an incredible demand from depositors for cash. The result: a complete breakdown in global financial markets," said Paul Kedrosky in Sunday's "Weekend Reading."You probably already knew (or at least heard) the balance sheet was an important part of any company's health, but did you realize that the numbers on that fundamental financial statement have a direct impact on the credit crunch we're facing?
In 2008, with stock prices fluctuating wildly (check out the CBOE Volatility Index) and "blue chips" looking somewhat less blue, the balance sheet has become more important than ever. Why? Simply put, credit is hard to come by. Scores of companies -- big and small -- use credit to finance their operations from day to day and month to month. With the credit pool drying up, those without the wherewithal on their balance sheets may find themselves in a seriously bad situation. Even solid borrowers like the State of California are finding themselves in a tough spot. The "Governator," Arnold Schwarzenegger, told the federal government that he may need up to $7 billion to run the state's day-to-day operations. But all that doesn't mean that there aren't plenty of companies out there with solid balance sheets.
Companies with little or no debt on their balance sheets -- such as Cisco Systems ( CSCO - Get Report) (no debt until the acquisition of Scientific Atlanta added a modest $6.5 billion to long-term obligations) and Google ( GOOG - Get Report) (no debt) -- are turning out to be bastions of safety for road-weary investors. Likewise, companies with mainly liquid assets (stocks and cash) or with tangible assets (inventory or land) are looking pretty good too. Simply put, when things turn bad, investors turn to quality.
the changes are good or not." Just look at DuPont ( DD): The chemical giant has seen assets grow 14% in the last five quarters while keeping its debt load essentially flat. That's a good trend. "Good" is a pretty relative term. Small regional banks saw triple digit gains in the last month, in part because the rest of the banking industry was in the midst of such catastrophe. While giants like Washington Mutual (recently bought out by JP Morgan Chase ( JPM)) and Wachovia ( WB - Get Report) crumbled, BancTrust Financial Group ( BTFG) ( BTFG) saw double-digit returns this quarter, due in no small part to no debt, a growing cash position (up 28% since 2006), and hope for insulation from subprime losses ( research shows that community banks were less likely to dole out subprime loans).
What should you look for when you're trying to pick the next rocket stock? Well, for starters, don't be fooled into thinking that there are red flags aplenty. According to Lamdin, "If we knew what
the red flags were, chances are the stock price would reflect this. There may be smaller less brightly colored ones that one can look for; inventories or accounts payables rising are worth looking into, for example." If you're looking at a stock with a strong balance sheet, don't forget about just how much valuation plays into the equation. Lamdin says, "A high-quality corporation with an overpriced stock is not a good investment, whereas an average-quality corporation with an underpriced stock is." Although not all companies with healthy balance sheet numbers are bound for double- or triple-digit glory, those without them are finding themselves in dire straits, as liquidity dries up in the credit market. Want a chance at making money in 2009? Stick to companies with solid balance sheets.