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Zooming in on Cash Flow to Debt Ratios to Determine Company’s Value

A significant measure of a company’s financial health is reflected in its cash flow to debt ratios, and based on a recent report, investors should pay particular attention to the amount of debt some S&P 500 companies are amassing.

While their cash balances are growing, so too are their debt levels. During the first quarter of this year, debt levels reached highs that had not been seen for at least a decade, according to FactSet, a finance research firm.

Despite this unsavory trend, there are some companies that are managing to keep their debt levels low, making them ideal candidates for those who use cash to debt ratios in determining how to invest. These include a couple of tech giants, which are a part of the information technology sector that has historically had cash balances that grew more than debt levels.

 · Importance of cash to debt ratios

Cash to debt ratios show how much cash a company has to pay off its debt. Investors want to see high ratios, which indicate that the company is well-positioned to pay off its debt. Furthermore, if that company needed to borrow more, the impact would not be as significant as it would be for a company with low ratios.

Many investors place more reliance on price to earnings ratios to measure a company’s financial health. However, some observers think that cash flow ratios are a better measurement of a stock’s value.

The metric can be particularly helpful due to the accounting method a company uses, such as GAAP, to report their earnings. The company may report strong profits, but through the lens of GAAP reporting, that amount could be less. Investors get a truer look at a company’s cash flow by look at their earnings based on GAAP.

Investors can also look learn more about a company’s cash flow-to-debt ratio by reviewing its EBITDA. The method is not considered as liquid as cash from operations, notes Investopedia. It also points out that without further information about the makeup of a company’s assets, it is difficult to determine whether a company is as readily able to cover its debt obligations in this method.

 · Cash versus debt

FactSet found that the growth in aggregate debt has outpaced that of cash among the companies in the S&P 500 index. Specifically, during the first quarter of 2016, debt grew to $4.2 trillion for the index, which was an increase of 9.9% year-over-year. That’s also an uptick of 3.3% from the fourth quarter of 2015.

Furthermore, the S&P 500 cash and short-term investments balance amounted to $1.45 trillion in the first quarter, according to FactSet. That marks a 5.7% increase from the year-ago quarter and a 1% jump from Q4 2015. Also noteworthy is that the balance in Q1 represented the largest cash total in at least 10 years.

Lastly, the cash to debt ratio fell 3.8% to 34.7% in Q1, which marked the lowest ratio since Q2 2009. The 10-year average cash to debt ratio is 36%.

 · Sectors, stocks with low ratios

Now that we’ve gotten all of those numbers out of the way, let’s get to the sectors and stocks that have attractive cash flow to debt ratios.

Six out of the nine sectors of the S&P 500 saw decreases in their ratios compared to the year-ago quarter, according to FactCheck. Those sectors were consumer discretionary, consumer staples, healthcare, information technology, telecom, and utilities.

The information technology sector maintained the largest cash balance, at $603.8 billion by the end of the first quarter. The sector saw its balance grow 20.1% compared to the first quarter of 2015. That was more than any other sector.

Microsoft (NASDAQ: MSFT) and Alphabet (NASDAQ: GOOG) topped the list of companies ranked by quarterly cash and short-term investments. At the end of the quarter, Microsoft and Alphabet had cash balances of $106 billion and $75 billion, respective.

If long-term investments are included in the company’s cash total, then Apple and General Electric top the list with balances of $232.9 billion and $129.7 billion, respectively.

2 responses to “Zooming in on Cash Flow to Debt Ratios to Determine Company’s Value”

  1. Really great info. This honestly isn’t stuff that I think about that often as I only own two individual stocks (the rest are all in mutual funds). Looking forward to learning more from your site in the future!

    • TwillyD says:

      That’s good to hear. There are so many variables that go into analyzing and determining a stock’s value. We’ll definitely be bringing you more pieces with ideas that may help you with your investment decisions.

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