In a business environment where the extension of credit is virtually non-existent, attention to the balance sheet is more crucial than ever. Gone are days where a company's rapid growth can make up for a highly leveraged balance sheet, at least for now.
Investors would be wise to really focus on the balance sheet in today's environment. A quality balance sheet will likely see a company through this recession. Not having to hold your hand out to creditors is a very big deal today. But most importantly, a strong balance sheet offers a greater margin of safety. If something goes wrong and - dare I say - a company has to liquidate, equity investors are more likely to avoid permanent losses of capital when the balance sheet is pristine.

IN PICTURES: 20 Tools For Building Up Your Portfolio

Count the Cash
One great outcome of this market mess is that Mr. Market got frightened to the point of extreme irrationality. Consider Facet Biotech (Nasdaq: FACT), which today trades for $9 a share and $14 a share in cash. If you strip out the debt, you get about $13 in cash. Indeed, this oncology research firm is currently in the developmental stage, but management seems to have a tight lid on expenses. Facet was spun off in December from PDL BioPharma (Nasdaq: PDLI) and was blessed with a cash rich balance sheet. Value investors will be comfortable knowing that Seth Klarman owns a nice chunk of Facet. (For more, read Testing Balance Sheet Strength.)

Forest Labs (NYSE:FRX) today trades for $23 a share, has zero debt and $7 per share in cash. Forest, which has an enterprise value of $4.7 billion today, has generated free cash flow of $596 million, $887 million, and $1.19 billion for fiscal years 2006, 2007, and 2008, respectively. The company relies on very little capital expenditure. Granted, its blockbuster Lexapro is going off patent in a couple of years, but the balance sheet and current share price provide a healthy margin of safety. (For more, read Breaking Down The Balance Sheet.)

I typically cannot handicap tech stocks very well, but Zoran Corp (Nasdaq:ZRAN) is worth a look for some investors. The fact that the company makes related products (think circuits) for DVD players and other home entertainment media doesn't excite me. What intrigues me is that shares trade for $9.70, the debt is zero and the cash per share is almost $7. To be sure, the company is not making a profit, but operating cash flows remain positive. The company has been around since 1981, so it's no fly by night operation. With so much cash and many well-known mutual funds in the stock, a potential catalyst exists for a cash distribution if nothing else.

Bottom Line
A cheap balance sheet is no guarantee of investment success, but a lot of good things can happen to a cash-rich company if all else fails. To be sure, investors will want to keep an eye out to make sure management is not burning through cash at an alarming rate. That's why it is good to have highly regarded investors involved who can step in if management gets messy. In the end, you're less likely to suffer crippling losses with a strong balance sheet in your corner. (For more, see Reading The Balance Sheet.)
.



Filed Under: ,
Tickers in this Article: FACT, PDLI, ZRAN, FRX

comments powered by Disqus

Trading Center