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Matthew

Since your are interested in discussion of the topic, and since I seem to have a few blessed moments of low pain levels, I'd like to rebut a few of your thoughts.

As for your pool -- I would bet that based on the ETFs reviewed that the bias would be towards a higher liability / equity status given the "stability" of the companies and their business franchises which can manage a higher leveraged status.

Regardless of who or what criteria were used to create a pool of companies, first I believe we are at the end of a multi-decade bull market (in prices) and bear market (in yields) for debt service of just about all types. Thus, ideas, such as you expressed in the quoted statement may have to be revisited for validity if, for example a similar length market in the opposite direction is about (or already beginning) to unfold.

Your statement encompasses the basic assumption that a good rate of return on assets or retained earnings is defined as one which is higher than the cost of debt service if the underlying project(s) producing those returns are financed. Not (necessarily) a bad assumption in a long term time frame of dropping debt service costs. But not (necessarily) a good assumption if rates get into a multi-decadal mode of steady to sometimes rapid rises in those costs.....especially if the liabilities not listed as debt are to an ever expanding (both in number and delta) claims rate from an older and retiring workforce.

But to your point, note that S&P 500 companies cash position as % of current assets rose from ~20% pre-Lehman to roughly 28% Q2'13 so I think there has been some adjustment to having a higher percentage of cash available for funding.

The problem with statistics such as the one to which you refer is the often embedded (at least in some reader's mental proclivities) that higher cash balances mean easier ability to meet total liabilities. This may, in fact, be the exactly correct way to interpret such a statistic. However, my spreadsheets show that cash on hand is only marginal when compared to total liabilities. What would be a more meaningful stat would be the correlation between cash growth in large US corporate balance sheets versus total liability change during similar periods. Then, if cash was growing faster than liabilities the chore is not yet completed, for one would have to also compare the rate of increase on existing liabilities to the rate of return on the cash increases. For example: suppose corporation "A" has $25 billion in total liabilities growing at 3% per annum and cash of $2 billion growing at 5% per annum. For ease of discussion let's assume that the rate earned on cash is the same as the rate charged on the liabilities. Is corporation "A's" headline of increasing cash reserves now to be viewed in the same light as might have been the case sans information about their liabilities?

For instance a Total Liability - to -Equity might be "less helpful" if there are significant share repurchases that lower the equity number. Like an IBM today or BUD in the past.

I agree, but that is not a pattern I often see. I am highly prone to view more favorably (in a situation where the financial performance of my key metrics are virtually identical) the company who reduced diluted shares (even if only by .5%, consistently) over ones where, coupled with that reduction there was in one of the companies also a reduction in shareholder equity greater than the one in diluted shares.

I'm not sure the aversion to using specific examples but they would be helpful in furthering the discussion.

I'm starting to wind down the current portion of lower pain, but I felt this needed some special attention. I didn't include specific companies for several reasons: 1). Virtually all of of you have your own screening and spreadsheet set-ups to be able to follow along; 2). I didn't want the discussion to become industry, sector, or company specific; 3). Some of the formulas I use (Jack Crow can verify this to some extent from the old days on FC) are not the accepted version by those with business school degrees, and I neither want to specifically share that thinking just yet, nor have the discussion lose focus on the issues of the impact of the various debt metrics which may be more inclusive than debt-to-ratio.

In 2008-9 this country (and most of the world, I guess) learned that lending, even short-term lending, can disappear virtually overnight. The recent Cypress bail-in procedure adds another layer of worrisome factors into this mix, in that the money held in accounts that are not FDIC insured or are above their limit can be seized in great chunks, virtually without notice.

For those who haven't read it, I've included a link to a white paper put out jointly by the FDIC and the Bank of England on what they call G-SIFI (Globally Active, Systemically Important Financial Institutions). Notice that this paper doesn't mention insured limits until after stability has been re-asserted (I read that as, until after they have seized enough money to stem the crisis). This paper was authored before Cyprus. If one reads the white paper and then reviews the news for what happened in Cyprus, the blueprint seems suspiciously clear. Highly leveraged companies (or high liability, if you will) companies now carry a layer of added risk for shareholders than they did a few years ago and should be approached in that light, for if a G-SIFI goes down (and the US has several of the biggest), then short-term and long term lending needs may go unmet for far longer than occurred in 2008-9

http://www.fdic.gov/about/srac/2012/gsifi.pdf

Poz
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