The S&P 500's Strongest Balance Sheets

I have written extensively over the past several months about the need to focus more on the balance sheet. I have explored several metrics to help identify companies with inferior financial strength or at risk of dividend cuts. With my expectation that we are now in a trading range with an upwards bias (730-880 on the S&P 500), I thought that it might make sense to use these same metrics to identify potential buys. If I am correct about further weakness later this year, it would seem as though we should be using the rally to upgrade the portfolio.

Comparing total liabilities (which include not only debt but also other obligations that can sometimes exceed debt quite significantly) to various components of the financial statements and also comparing the value of the stock to its accounting book value could allow us to identify companies better able to weather the storm. I constrained the universe to the S&P 500 and included the following parameters:

• Liabilities/Current Assets <1
• Liabilities/EBITDA <3
• Liabilities/FreeCashFlow <5
• Price/Tangible Book <4

While these are nice attributes and do suggest a potential margin of safety, they are no guarantee that the stock price won't decline. In fact, as you can see in the table below (click to enlarge), many of these stocks have declined significantly this year (though the entire list is doing better on average than the market). It is worth remembering that using accounting statements implies relying upon historical events - EBITDA and FCF are backwards looking. Additionally, assets may become impaired, so CA could be overstated (AR, Inventory) and, consequently, Tangible Book too may be lower than the balance sheet indicates. With those caveats, here are the 28 names that made the cut:

Several economic sectors are represented, though clearly Tech is represented disproportionately. While almost all of the charts look like they are potentially bottoming or basing, a few stand out: Akami (AKAM), Cognizant (CTSH) and Xilinx (XLNX). Perhaps they are "ahead of themselves", but they have all penetrated longer-term moving averages.

If you like the concept of upgrading to companies with strong balance sheets and are open to smaller companies, I have good news: Using these same metrics, there are a lot more names that meet the criteria. While less than 6% of the S&P 500 made this list, 8% of the Russell 2500 does (the Russell 3000 less the top 500 names).

Finally, I included a column for dividend yields. While one can never be sure how defensive a company might become in this environment, it seems very unlikely that any of these companies would cut their dividend. With that said, though, I am aware that at least one did: Titanium Metals (TIE). Perhaps some of the ones on the list that haven't paid a dividend historically will decide to do so now.

Disclosure: Long ISRG and ZMH

Comments

[Zoltan L. K...:]

Nice to see Apple on your list, they really deserve it. But they have only made it because you put hurdle rate for Price/Tangible Book <4. It is in fact natural for a company with such innovative potential like AAPL to have a price way over the value of the tangibles.

Mar 22 06:45 AM

[Zoltan L. K...:]

Sorry, just one correction: I guess you ment Price/Tangible Book less or equal 4.

Mar 22 06:47 AM

[Alan Brochs...:]

I wasn't sure how much to restrict P/TB. It amazes me how many companies now trade at less than tangible book, but most of these have a lot of debt or tend to be very small. My main goal in including that variable was to get rid of the companies with very little (or negative) tangible equity. Clearly AAPL or PCP have a lot less downside protection than ESV or TIE in that regard. You make a very valid point, and hopefully the market will continue to recognize that some companies have intangibles that are worth something.


On Mar 22 06:45 AM Zoltan L. Kovacs wrote:

> Nice to see Apple on your list, they really deserve it. But they
> have only made it because you put hurdle rate for Price/Tangible
> Book <4. It is in fact natural for a company with such innovative
> potential like AAPL to have a price way over the value of the tangibles.

Mar 22 07:34 AM

[ArtfulDodger:]

Mr. Alan Brochstein:

That's some very good info. I like this metric a lot: Liabilities/FreeCashFlow <5.

Thanks for the run down.

Mar 22 08:35 AM

[Gunns:]

Not every day you see the argument for Nucor having "financial strength"...

Pensions, pensions, pensions...

Mar 22 10:46 AM

[Alan Brochs...:]

They made the cut. Upon closer examination, they sure have a lot of inventory. Even if one cuts it in half, though, they still have plenty of cash and other short-term assets to cover near-term and most of their longer-term liabilities. Their FCF generation will most likely plunge, but I find it interesting that the company hasn't ever lost money over the past 35 years (which is as far back as my data goes). At 2X tangible book, though, clearly the stock has some downside if their earnings plunge.

On Mar 22 10:46 AM Gunns wrote:

> Not every day you see the argument for Nucor having "financial strength"...
>
>
> Pensions, pensions, pensions...

Mar 22 11:55 AM

[TeresaE:]

Robert Half International is NOT an industrial stock.

Robert Half is an Accounting/Finance/Tech temp firm.

Of course they have a strong balance sheet, you can't show people as assets, and their inventory (workers) is bulging while their customers are being bankrupted.

Mar 22 08:54 PM

[ding:]

Made in Germany, there is no excuse for belittling and insulting others. You do a dis-service to all, but mostly to yourself. You can do better.

Mar 23 11:07 AM

[Alan Brochs...:]

S&P classifies it as an "Industrial"... On your point about their balance sheet, it is quite strong compared to peers and to other business services providers, though I appreciate your comment upon their fundamental outlook.

Make no mistake, this list wasn't a buy recommendation by any stretch, but rather a list of companies that might survive better than others...


On Mar 22 08:54 PM TeresaE wrote:

> Robert Half International is NOT an industrial stock.
>
> Robert Half is an Accounting/Finance/Tech temp firm.
>
> Of course they have a strong balance sheet, you can't show people
> as assets, and their inventory (workers) is bulging while their customers
> are being bankrupted.
>
>
>

Mar 23 05:02 PM