I recently published an article on Seeking Alpha about several companies with great balance sheets.
8 Dividend Stocks With Particularly Strong Balance Sheets
I utilized four primary financial health metrics and explained why I find them to be important:
-Debt/Equity
-Current Ratio
-Goodwill/Equity
-Interest Coverage Ratio
Posting is a bit light this week because I’ve got quite a bit of material planned for the next two weeks, assuming all goes well.
defensiven
Goody posty. I like the goodwill/equity. A bit offtopic: Read the other day that investors should prefer lower earnings then reality as this lowers company tax (leaving more cash for dividends etc). Maybe goodwill is a valuable asset for tax reasons? As I suppose the tax decreases when goodwill is written down.
Matt
Hi Defensiven,
When companies report earnings that are lower than what the real picture is, it typically does help investors because the tax burden is reduced. A prime example of this is owning MLPs, because these businesses typically report net income that is much, much lower than what their real sustainable cash flows are due to massive depreciation deductions.
What you mention about goodwill being a useful tax asset is interesting, because writing down goodwill may indeed help with income taxation. However, this may be offset by having a lower credit rating and therefore higher interest rates on their debt. I believe that companies have their goodwill taken into account when a company is analyzing them and assigning a credit rating, so although having goodwill to write down every year may reduce taxation, it may also lead to higher interest rates on the debt. It would be interesting to see a more in-depth study on this to see what the net effect is, since I’m not sure.
My Own Advisor
Good post Matt. I would like to own about half of those stocks, only own one to date: JNJ.
Dividend Growth Investor
Prior to 2001 I believe companies could amortize goodwill over a period of 40 years. This artificially decreased income for decades to come. Nowadays, companies have to go through a two step impairment process, before they could take an “impairment” charge against earnings. As a result earnings appear to be more volatile because of these events. For reference, check out COP’s EPS in 2008.
defensiven
To continue dividend growth investors comment, here is Wikipedia (regarding current US GAAP and IFRS):
“Instead of deducting the value of goodwill annually over a period of maximal 40 years, companies are now required to determine the fair value of the reporting units, using present value of future cash flow, and compare it to their carrying value (book value of assets plus goodwill minus liabilities.)
If the fair value is less than carrying value (impaired), the goodwill value needs to be reduced so the fair value is equal to carrying value. The impairment loss is reported as a separate line item on the income statement, and new adjusted value of goodwill is reported in the balance sheet.”