Hunting for the Hottest Stocks? Look at Debt Loads
This year's best-performing stocks have the best-looking balance sheets, punctuating investors' diminished appetite for risk-taking in the wake of the credit and housing-market turmoil.
Apple Computer, Google, Microsoft and T. Rowe Price are among 31 companies in the Standard & Poor's 500 with no debt.
They are also companies whose stocks are outperforming the broader equity market, according to Paul Hickey, co-founder of Bespoke Investment Group in Mamaroneck, N.Y.
"With credit markets continuing to show signs of weakness, companies that rely on the debt markets to fund their regular operations, or buyback programs, will see their borrowing costs rise," Hickey said.
"How will this impact their stocks?" he asked in a recent report to clients.
Evidently, a lot.
Hickey found that the shares of companies in the S&P with zero debt are "doing the best by far" with a gain of more than 17 percent this year.
Conversely, the stocks of companies with debt-to-equity ratios of more than 10 percent are up just 4 percent for the year, he added.
And the denizens of Corporate America whose debt levels were low -- debt-to-equity ratios not more than 10 percent -- are experiencing an increase in their stock prices of more than twice that with a gain of 9.29 percent, Hickey added.
"Debt levels always matter, but there is an emphasis on debt loads whenever the economy slows," said Keith Wirtz, chief investment officer of Fifth Third Asset Management, which manages $22.5 billion, in Cincinnati.
It's no surprise that 24 S&P companies fall into the top-performing technology sector.
Tech firms tend to generate significant quantities of cash owing to their ability to produce additional gross profits with just marginal costs, not to mention the sector has had little M&A activity over the years.
"Tech companies also want to have cash to weather various product cycles," Wirtz added.
Tech shares are among Wirtz's top picks this year, but not for their lack of liabilities.
"We've held an 'overweight' in tech companies all this year because of their fundamentals more than their lack of leverage," he added. "They were also substantially out of favor last year," which is when Wirtz delved into the sector.
The sector's fundamentals remain bright with increased business spending on upgrades of software, computers and other equipment projected, he said.
Tech companies are much more exposed than any other sector to international markets -- which are growing at a robust pace -- than the domestic U.S. market, which is slowing.
"So that encourages us to think about tech," particularly since the dollar is weakening, Wirtz added.
The weakening dollar makes tech companies' goods cheaper for other countries.
Wirtz owns some of the debt-free companies, including Apple, Google, Microsoft and Qualcomm . But he said with the huge rally in Apple, which is up over 120 percent this year, and Google, up over 57 percent for the same period, "we are reducing our position as their stocks continue to rise -- but we're still above market-weight in these names."