Some companies have far more tangible* assets than liabilities (Intel, Public Storage, Skechers USA). Unlike the previous examples, most US companies are not so strong; about 12% of the largest 1,000 US companies have over $1.30 in debts for every $1.00 in tangible assets. Many of the largest US companies are even far more leveraged. The risks of a company rise in direct proportion to the degree to which its’ debts are larger than its tangible assets. What percentage of your retirement fund do want invested in companies with more debt than tangible assets?
Some companies have far more free-cash* than they could possibly need (Apple, Google, Nike). (Caution: while a company’s cash position adds greatly to the safety of the enterprise, it adds to the safety of their stock price!) Unlike the previous examples, most US companies are not nearly so strong; about 62% of the largest 1,000 US companies have less than 100% more free-cash than they have in current liabilities. Cash is the lifeblood of every company. The cash that a company can easily and freely distribute to its shareholders is an excellent measure of a company’s financial strength and its value. How much of your retirement funds should be invested in companies with poor cash production?
Many US companies have strong and predictable revenue streams, may do not. (Amazon, Netflix, Cree) Clearly, companies with growing revenues are preferable to those with declining revenue. However, when the debts of a company grow faster than their revenues, we worry. How much of your retirement funds should be invested in companies whose debts are growing faster than their revenues?
Many US companies have paid dividends reliably for a century or more. (Coca-Cola) Generally, the higher a company’s dividends are, the more valuable their stock is. However, if a corporation borrows money to pay its dividend, we worry. If a company pays out $2 billion over 5 years but it added $4 billion to its debt, its dividend payments may be a sign not of strength, but of weakness. For companies that pay dividends, we look at where the money to pay them comes from. Dividends financed through debt represent a far riskier scenario than those not corresponding to rising debt levels.
When Can “Earnings per Share” actually be Worthless?!
Can US public company’s report billions in annual earnings and rising earnings every year, for a decade or more, and yet not show any increase at all in the company’s net assets? Can company’s report tremendous earnings and even show a deteriorating balance sheet over time? (Sirius XM Holdings, El Paso Pipeline Holdings, Biogen Idec) Yes they can, on both counts; and never be convicted of fraud. In the words of Abraham Briloff, CPA, Ph.D., “Financial statements, like fine perfume, should be sniffed, not swallowed.” How much of your retirement funds are invested in companies with rising earnings, but deteriorating balance sheets?