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Corporate bankruptcies will not be nearly the problem that some would like us to think

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May 14, 2009 – Comments (8) | RELATED TICKERS: UL , MMM , ABT

 

I've been hearing some people talk about the coming Armageddon of corporate bankruptcies..that some absurdly huge percentage of all public companies will eventually file.  While there's no doubt that many companies levered up too much over the past several years and that the number of corporate bankruptcies will rise, the facts actually show that most companies were in very good shape financially going into this recession.

According to a recent study that was published by The Journal of Finance, between 1980 and 2006 the amount of cash held by the average U.S. company ballooned from only 10.5% of assets to 23.2%.

For his latest column in Smart Money magazine, Jack Hough had Compustat update this study.  Despite the recent economic weakness, the percentage of cash on companies' balance sheets still sits at 22% a solid of companies' total assets (excluding banks and utilities which have cash requirements set by regulators).

There are countless examples of companies out there that have huge piles of cash to protect themselves during this downturn while they adjust their production capacity to what I believe will be a slow growth environment for the next several years.  For example, Apple (AAPL) and eBay (EBAY) have enough cash on the books to pay a one-time dividend of 20% of their current market caps.  Dell (DELL) could pay as much as 40%.

The reason I made this post is to point out that many companies are not in the dire financial shape that many would like us to believe.  Yes some companies like poorly run automakers, and possibly even some states...see my post on New Jersey from a few days ago, will file for bankruptcy.  However, most companies came into this mess in pretty good shape financially with lots of cash. 

Furthermore, the credit markets are in much better shapoe today than they were a few short months ago.  Companies that have debt maturing in the near future are now actually able to refinance it, perhaps at slightly higher rates than they'd like but the market is no longer frozen.  For a period of several months that was not the case.  That's bad news for bond investors like myself who can't find the amazing deals that were available several months ago, but it's great news for companies and the economy. 

Later on in the Hough article he talks about the importance of dividends.  He published an interesting list of stocks that popped up when he ran one of his famous stock screens.  For this query, he looked for companies that pay out more than half of their profits as dividends...but not more than 80%, that don't sit on huge piles of cash...but have low debt, and that have reasonable valuations.

The five companies that he came up with are Unilever (UL or UN), Kimberly-Clark (KMB), 3M (MMM), Abbot Labs (ABT), and Diamond Offshore (DO).  I currently own UL in real life and am long KMB, MMM, and ABT in CAPS.  I will likely add to my UL position in the future when I have the cash to do so.

Unilever is a stable consumer staples company which owns quality brands like Vaseline, Dove soap, Slim-Fast, Lipton tea, etc...  The company is very well run, is benefitting from the significant drop in commodities prices and from consumers spending more time at home during these hard times, trades at only 12 times earnings, and has a 6% dividend. 

I would never buy Kimberly-Clark in real life because its huge pension problems scare me.

I used to own Diamond and believe that it is a very well-run company, but I sold it a while ago when I first sensed weakness in oil.  It probably would be a good company to pick up on the cheap while prices are low and hold onto for a number of years, but I'm waiting for now.

3M is an awesome company that I used to own as well, but I'm concerned about the recession's impact upon its business...particularly its automotive business.  Still this Dividend Aristocrat is worthy of a place in my CAPS portfolio.  Plus 2/3 of its business comes from outside of the U.S. so it is a great way to play the weakness in the U.S. dollar that many are anticipating.

Last but not least we have Abbott Labs.  At only 12 times earnings and sporting a 3.6% dividend yield it looks pretty attractive to me at first glance, but I'm not going to pretend that I am very familiar with this company because I'm not.

Deej

8 Comments – Post Your Own

#1) On May 14, 2009 at 12:38 PM, drummnutt (< 20) wrote:

good post.

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#2) On May 14, 2009 at 12:54 PM, 4everlost (29.36) wrote:

Thanks for the insight...

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#3) On May 14, 2009 at 2:59 PM, portefeuille (99.59) wrote:

For his latest column in Smart Money magazine, Jack Hough had Compustat update this study.

Could you provide the link for that? (please include them if possible, I hate google searches, especially if unsuccessful ...)

Despite the recent economic weakness, the percentage of cash on companies' balance sheets still sits at 22% a solid of companies' total assets ...

Could that be (in part) be due to quickly declining non-cash assets?

Here is a link to an article by that author on P/E ratios for different stock markets. I highly doubt the 20.2 number listed for Germany (Estimated P/E for the iShares MSCI Germany Index ETF (EWG) "From ETF sponsors, adjusted for price changes since last reported" (no link for that, I am fed up with google ...)). 

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#4) On May 14, 2009 at 3:08 PM, portefeuille (99.59) wrote:

Could that be (in part) be due to quickly declining non-cash assets?

cross out one of the "be"s ...

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#5) On May 14, 2009 at 3:42 PM, TMFDeej (99.40) wrote:

Thanks for reading everyone.

Hi Port.  I got the information from my old school, hard copy of Smart Money Magazine.  I looked around but was unable to find a link to the article on-line.  Perhaps SM isn't making it available there.

Deej

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#6) On May 14, 2009 at 3:44 PM, devoish (98.64) wrote:

Deej,

The first question that jumps to my mind is if cash has doubled since 1980 what has debt done? Or even interest payments. And portefeuille's question is also a good one.

Thanks for all your help.

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#7) On May 14, 2009 at 5:39 PM, alstry (35.36) wrote:

You are so naive my little Padawan....

Just a few years ago....we were bragging how Americans had the most equity in their homes in history.....now we have been reduced to the least........in just two years.

If revenues to our major corporations are declining 30, 40, and 50%....MOST corporations will go bankrupt in such an environment or will be forced to reduce to a fraction of their previous size.....

No corporation is immune from this phenomenon....including Motley Fool.

Don't worry....I have little doubt you will eventually see the light.....or else get burned by the fire.

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#8) On May 15, 2009 at 12:08 PM, OleDrippy (34.15) wrote:

#6)

Bingo...

 

Cash is only part of the equation.. I'd be curious what the liability side of the balance sheet is looking like. The argument is there are far too many companies in existence due to cheap money and leverage. With a downturn in sales/earnings those companies will be exposed and go bankrupt.. It's ok, though.. The system needs a cleansing every now and again..

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