Word of Caution on Highly Levered Companies
The stock market is flying ever upward this week. On Tuesday, I did my third CSW seminar at Mississippi State’s Meridian Campus. That day, the Dow Jones Index was up well over 200 points early in the day, only to close down by over 100 points. Then the Fed spoke and all was well again. (hint of satire)
As you know well by now, I favor value stocks since I want to pay for value that already exists over paying for value that “might” be in the future. Default risk is the risk that matters most because if the company I’ve invested in goes under, my investment in that company will never recover. Value to me is defined by the balance sheet and represents a financially solid company that stands a great chance of weathering a financial storm or setback if that comes to pass, and live to see a better day. As described in my book, “Choose Stocks Wisely,” before focusing on the balance sheet health, I experienced some bad investments that failed to weather financial storms.
Value stocks have been out of favor for a spell now while companies with weaker balance sheets (building up debt to lever higher earnings per share) have driven the stock market. See my post from late spring which cited articles on the matter here. Yet, the balance sheet always matters and when excessively leveraged companies face an adverse change in the demand climate, watch out because leverage compounds the downside just as it does the upside.
Taking on excessive leverage greatly increases the risk of default if the industry/sector weather turns inclement. Just consider that amidst the current elevated market indices that energy stocks are not participating to say the […]