What are we looking for?
Despite unprecedented economic hardship and possibly the sharpest recession in history, stock markets continue to rally even as companies remove guidance. This poses the question: How long can markets ascend while underlying companies are unsure of what their futures entail, and which ones may be better positioned to withstand future volatility?
To examine that question, we decided to look at companies with low net debt as a percentage of equity value. These firms may be insulated from a potential second downturn because of improved financial flexibility and limited debt obligations, lowering the risk of a credit default at a time when default risks are high.
The screen
To begin our analysis, we used FactSet’s Universal Screening tool to look at the constituents of the S&P 500.
We then narrowed our universe to companies with a market capitalization more than US$1-billion to reduce the risk of including those that have high cash balances but also burn through it quickly – less likely with larger-cap firms. Next, we narrowed our universe further by looking for negative net debt: In other words, we include only companies that had more cash and short-term investments than total debt as of their last quarterly report-date. (We excluded companies in the financial sector as net debt may be overly simplistic owing to the complexity of bank balance sheets.)
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What we found
We examined the S&P 500 during the recent turbulence and found that the market topped on Feb. 19 and bottomed on March 23, falling a staggering 33.9 per cent between those dates. The median company in our universe fell 28 per cent over this period, suggesting several companies with higher cash positions fared better during this time.
Some 50 total companies passed our initial screening criteria; the Top 10 based on cash position are included in the accompanying table.
Regeneron Pharmaceuticals Inc. was our top performer and gained 13.7 per cent from peak to trough. It held cash and short-term investments of US$4-billion as of its last fiscal quarter end, which makes up a substantial portion of its US$67.5-billion equity value. The company’s performance may have been influenced by positive news surrounding their Eylea eye-treatment drug. Regeneron was one out of only five companies in the entire S&P 500 that had a positive return during the market crash.
Unsurprisingly, video-game developers also did well. Take-Two Interactive Software Inc., Activision Blizzard Inc., and Electronic Arts Inc. placed second, fourth and sixth, respectively, with excess returns of 30.6 per cent, 21.7 per cent and 20.9 per cent. Their net debts as a percentage of market capitalizations came in at minus 15.3 per cent, minus 5.7 per cent and minus 12.7 per cent, and substantially lower than the 23.5 per cent for the median company in the S&P 500. Gaming appears to be a beneficiary of the stay-at-home trend as more people look for indoor activities during the pandemic.
Costco Wholesale Corp. and Hormel Foods Corp. ranked third and fifth, respectively, with excess returns of 22.3 per cent and 21.3 per cent, respectively. Costco had a net-debt position of minus US$144-million while Hormel had minus US$307.8-million as of their latest quarter-ends. They outperformed other consumer firms that are also positioned to do well as a result of lockdowns, which may suggest that having a strong cash position is benefiting these companies relative to peers.
In the event of a continued stock market recovery, we discovered that the median company in our Top 10 list is up 12.7 per cent year to date, as opposed to the S&P 500, which is down 5.4 per cent. These firms may provide investors an opportunity to participate in upside potential while limiting downside risk, given their strong balance sheets and performance during the recent market downturn.
The information in this article is not investment advice. FactSet assumes no liability for any consequence relating directly or indirectly to any action or inaction taken based on the information contained above.
Arjun Deiva, CFA, is vice-president at FactSet’s Canada consulting division.
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