Either way, priority number one should be avoiding companies that might run short of cash in the event of an unexpected business slowdown. Just the rumors that your stock might be facing bankruptcy would sink its share price.
Thus, it’s best to stick with stocks unlikely to suffer that fate. I call them “bulletproof stocks.” Here’s how to find them.
Screening For Stocks That Can't Go Broke
Identifying bulletproof stocks involves developing a set of requirements that firms with weak or potentially weak balance sheets can’t possibly meet. You can then use a stock screen to find qualifying stocks. Stock screens are programs available on certain financial websites that allow you to search the entire market for those meeting your specific requirements.
I’m going show you how to use the free Custom Stock Screener offered by Zacks Investment Research to isolate bulletproof stocks: debt-free, profitable companies with plenty of cash in the bank.
Find the screener by selecting “Screening” from Zacks homepage (www.zacks.com) and then click on Custom Screener. The screener is easy to use once you get the hang of it. The available search terms (parameters) are divided into categories such as Valuation, Balance Sheet, Return on Investment, etc.
You use it by selecting a category containing a search term of interest, filling in the required information for that parameter, and then clicking “Add.” The trickiest part of following my description will be finding my specified search terms, so I’ve listed the corresponding category name in parenthesis after each search term description. If you’re rusty on your math terms, you need to know that “>=” translates to “equal to or greater than,” and “<=” means “equal to or less than.”
Here’s how to construct the bulletproof stocks screen.
No Debt – No Problem
Start by limiting the list to debt-free firms. The debt to equity ratio compares long-term debt to shareholders equity (book value). Zero values reflect no long-term debt and the higher the ratio, the higher the debt. Although we want zero debt, setting the maximum allowable D/E at 0.1 allows companies carrying incidental debt such as long-term leases to pass. Debt/Equity Ratio <= 0.1 (Liquidity & Coverage)
Cash is King
Next, isolate stocks with plenty of cash on hand to cover current bills. The quick ratio compares the total of cash in the bank plus accounts receivables (cash due from customers) to current bills (current liabilities). Specifying a minimum quick ratio of 2.0 means that cash plus receivables must be at least double the current liabilities. Quick Ratio >= 2.0 (Liquidity & Coverage)
Avoid Cash Burners
Cash in the bank isn’t enough. You need to know that those bank balances aren’t going to disappear. Operating cash flow measures cash that flowed into or out of a firm’s bank accounts from its operations. Unlike earnings, which can be manipulated, cash flow must match real bank balances. For this test, you only need to know is that cash flowed in, not out (burning cash). For this purpose, the amount doesn’t matter. Cash flow (millions) >= 0.001 (Income Statement & Growth).
Trust But Verify
While the positive cash flow requirement should be sufficient to assure that passing firms are profitable, you can’t underestimate the creativity of motivated accountants. Checking for positive net income helps to assure that the firm is profitable. Net Income (millions) >= 0.001 (Income Statement & Growth).
Most stocks rack up annual sales well in excess of $100 million. Requiring $50 million rules out companies that aren’t real businesses. Annual Sales >= 50 (Income Statement & Growth)
Cheap Just Gets Cheaper
Cheap stocks get that way when savvy investors spy serious problems ahead. Requiring a minimum $5 trading price rules out stocks facing issues that the screen may have missed. Last Close >= 5 (Price & Price Changes)
When I ran the screen, it turned up 371 stocks. Here's the list: http://goo.gl/W3EX3.
Qualifying as bulletproof only means that a stock isn’t a bankruptcy candidate, not that you’ll make money owning it.