Balance Sheets 101: Who Might Survive This Crisis

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 Apple's ( AAPL) recent earnings announcement and conference call. (Don't miss " Apple Brings Bright Spot to Tech")

    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:

    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 market capitalization is represented by its cash.

    Now let's find other companies with strong Apple-like balance sheets.

    Using the Bloomberg Professional 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. Bloomberg Professional 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:

    Net Cash Kings
    Ticker Company Net Cash (in U.S. Dollars) Market Cap Net Cash Percentage of Market Cap Stock Price (mid-11/4/2008) P/E
    ORH ODYSSEY RE HLDGS 5,969,780,832 2,588,600,832 230.6% 40.85 21.96
    WCG WELLCARE HEALTH 1,484,410,928 1,030,139,328 144.1% 24.7 5.09
    FDRY FOUNDRY NETWORKS 1,597,632,960 2,130,404,352 75.0% 14.47 27.83
    HLTH HLTH CORP 778,224,032 1,519,250,432 51.2% 8.24 10.99
    KG KING PHARMACEUT 794,578,928 2,186,364,928 36.3% 8.87 5.38
    ERTS ELECTRONIC ARTS 2,464,999,936 7,390,295,040 33.4% 23.18 18.98
    LSI LSI CORP 825,176,032 2,529,434,880 32.6% 3.93 10.08
    FLR FLUOR CORP 2,033,299,040 6,699,995,648 30.3% 37.43 13.06
    IACI IAC/INTERACTIVEC 662,409,952 2,318,274,816 28.6% 16.57 30.69
    MXIM MAXIM INTEGRATED 1,256,455,984 4,457,931,264 28.2% 13.99 11.96
    BEN FRANKLIN RES INC 4,387,879,904 16,086,798,336 27.3% 68.67 10.3
    AAPL APPLE 24,490,000,384 95,015,346,176 25.8% 106.96 19.92
    BRCM BROADCOM CORP-A 2,246,730,048 8,719,339,520 25.8% 17.08 18.98
    JNPR JUNIPER NETWORKS 2,020,936,896 9,876,121,600 20.5% 18.17 18.17
    EBAY EBAY INC 3,643,852,928 19,166,924,800 19.0% 15.01 9.44
    WDC WESTERN DIGITAL 707,999,936 3,773,205,760 18.8% 17.03 3.77
    YHOO YAHOO! INC 3,214,099,968 17,668,820,992 18.2% 12.75 29.65
    ALTR ALTERA CORP 872,596,968 4,983,860,224 17.5% 16.76 15.1
    GPS GAP INC/THE 1,492,000,000 8,914,062,336 16.7% 12.53 9.56
    GOOG GOOGLE INC-CL A 14,412,609,024 108,952,543,232 13.2% 346.49 21.56
    MA MASTERCARD INC-A 2,317,597,056 18,587,017,216 12.5% 143.89 17.76
    AMAT APPLIED MATERIAL 2,094,767,888 17,387,911,168 12.0% 12.96 13.94
    V VISA INC-CLASS A 5,227,999,808 44,374,523,904 11.8% 52.49 22.43
    ADBE ADOBE SYS INC 1,650,903,872 14,420,767,744 11.4% 27.16 15.79
    QCOM QUALCOMM INC 6,613,999,872 61,043,798,016 10.8% 37.2 19.18
    CELG CELGENE CORP 2,454,169,984 29,887,633,408 8.2% 65.23 51.48
    TXN TEXAS INSTRUMENT 1,993,000,064 24,515,395,584 8.1% 18.91 10.28
    ATVI ACTIVISION BLIZZ 1,252,714,048 15,676,234,752 8.0% 11.89 9.91
    AMZN AMAZON.COM INC 1,889,000,000 23,915,982,848 7.9% 55.77 41.01
    NKE NIKE INC -CL B 1,932,799,936 27,094,788,096 7.1% 55.84 15.34
    GENZ GENZYME CORP 735,044,032 19,756,777,472 3.7% 73.54 23.42
    Source: Bloomberg

    Thus, Odyssey Re: Holdings ( ORH) 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 less its cash, plus its debt. This represents the true cost of buying a company if done at market value. So in the case of Juniper Networks ( JNPR), 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 " How to Find Value With the Z-Score and Pitroski Scale," 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 Bloomberg Professional 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 Odyssey Re ( ORH), Franklin Resources ( BEN) and Visa ( V) were excluded in the table below:

    Z-SCOREBOARD
    Ticker Company Stock Price (mid-11/4/2008) P/E Z Score
    GOOG GOOGLE INC-CL A 346.49 21.56 32.87
    CELG CELGENE CORP 65.23 51.48 23.78
    QCOM QUALCOMM INC 37.2 19.18 18.40
    ADBE ADOBE SYS INC 27.16 15.79 12.91
    ATVI ACTIVISION BLIZZ 11.89 9.91 10.94
    AAPL APPLE 106.96 19.92 10.34
    TXN TEXAS INSTRUMENT 18.91 10.28 10.29
    MXIM MAXIM INTEGRATED 13.99 11.96 9.76
    YHOO YAHOO! INC 12.75 29.65 8.35
    AMZN AMAZON.COM INC 55.77 41.01 7.73
    FDRY FOUNDRY NETWORKS 14.47 27.83 7.67
    ERTS ELECTRONIC ARTS 23.18 18.98 7.61
    NKE NIKE INC -CL B 55.84 15.34 7.20
    GENZ GENZYME CORP 73.54 23.42 6.53
    FLR FLUOR CORP 37.43 13.06 6.42
    JNPR JUNIPER NETWORKS 18.17 18.17 6.27
    AMAT APPLIED MATERIAL 12.96 13.94 5.94
    BRCM BROADCOM CORP-A 17.08 18.98 5.77
    ALTR ALTERA CORP 16.76 15.1 5.62
    GPS GAP INC/THE 12.53 9.56 5.16
    EBAY EBAY INC 15.01 9.44 4.55
    WDC WESTERN DIGITAL 17.03 3.77 4.55
    WCG WELLCARE HEALTH 24.7 5.09 4.30
    KG KING PHARMACEUT 8.87 5.38 3.83
    MA MASTERCARD INC-A 143.89 17.76 3.83
    LSI LSI CORP 3.93 10.08 1.14
    IACI IAC/INTERACTIVEC 16.57 30.69 0.82
    HLTH HLTH CORP 8.24 10.99 (5.00)
    Source: Bloomberg

    All of the companies from the search yielded high z-scores, with the exception of LSI ( LSI), IAC Interactive ( IACI) and HLTH Corp. ( HLTH).

    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:

  • Macy's (M):1.94
  • General Motors (GM): -0.07
  • Time Warner (TWX): -0.14
  • The empirical z-scores seem to confirm my opinion that all three of these companies are in critical financial condition.

    Your Homework

  • 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 www.lakeviewasset.com. Scott appreciates your feedback; click here to send him an email.

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