Corporate 'Fire' Isn't Always Bad

At a Berkshire Hathaway (BRK-B) annual meeting I attended in the 1990s, Warren Buffett said he only had one skill... [Chaikin PowerFeed]( Corporate 'Fire' Isn't Always Bad By Marc Gerstein, director of research, Chaikin Analytics At a Berkshire Hathaway (BRK-B) annual meeting I attended in the 1990s, Warren Buffett said he only had one skill... It was the ability to allocate capital. Now, you might think that process would be straightforward. [But as I explained recently]( Buffett's decision-making prowess often breaks with common assumptions. Today, we're going to look at another one of those breaks... You'll see that this essay is all about debt. More specifically, we'll cover how sensible allocation between two types of capital – equity and debt – can boost a company's returns... Recommended Links: [Prepare NOW for Retirement Lockdown]( With inflation soaring, stocks crashing, and a potential recession looming, a former Goldman Sachs banker and renowned retirement expert is stepping forward with his urgent No. 1 recommendation to protect and grow your money in today's dangerous economy. [Click here for details](. [A Massive Wave of Bankruptcies Is Coming]( It's actually much bigger and more important than what happens to the Nasdaq or S&P 500. Some of the world's best investors are practically drooling in anticipation. That's because this crash will create a slew of 100%-plus opportunities... backed by legal protections that stocks can only dream of. A top analyst believes this could happen within months. [Get the full story here](. Think of debt as "fire"... Left uncontrolled, a fire can destroy and kill. But humanity learned eons ago how to control fire – and to harness its power. Likewise, we can harness the power of debt to make things better. Consider your personal life... Mortgage loans allow you to buy a bigger, better home than you could get if you just paid cash. Business owners can "leverage up" by taking on debt, too. They can light a fire under their business. As long as it's taken care of, that fire can stoke the company's returns. But if it's left uncontrolled, it will burn the company to the ground. That's why leveraging up isn't for all companies. Simply put, debt means interest payments. And the company must make those payments even when business temporarily turns down. If not, too bad... It's pay up – or else. In most cases, "or else" means bankruptcy. Other times, debtors linger as "zombie" companies. Either outcome is bad news for shareholders. So leveraging up is only for two kinds of companies... It's for the companies consistently making enough money every year to pay their interest. Or it's for the companies that make enough in good years to save for a "rainy day." By that, we mean a down year in which the company doesn't earn as much as it needs to pay interest. Here's where Warren Buffett's trick comes in... He's not afraid to invest in companies with a lot of debt. But most importantly... Buffett tends to buy companies that can easily make the interest payments on their debt. In short, when Buffett invests Berkshire Hathaway's funds into other public companies, he's willing to choose businesses that can productively handle their debt... The median long-term debt-to-equity ratio among companies in which Berkshire Hathaway holds large stakes is roughly 1.6. In comparison, the median long-term debt-to-equity ratio of the S&P 500 Index is around 0.7 today. And the median interest-coverage ratio – which measures the availability of operating profit for use in paying interest – is 13.1 for Berkshire Hathaway. For the S&P 500, it's 10.4. So we can see that companies in Berkshire Hathaway's portfolio can afford to service their debt. Now, let's see if using debt lets these companies boost their returns beyond what they could've achieved without borrowing... For that, we'll look at return on assets ("ROA"). This metric shows what a company earns on all of its capital. It's comparable to "how much house" you get for the price you pay (down payment plus mortgage debt). The five-year median ROA for Berkshire Hathaway's large holdings is 3%. That's less than the S&P 500's 5.6% for this metric. But don't jump to a negative conclusion... Return on equity ("ROE") is another measure of profitability. It shows how much the company earned only from the owners' equity. This is comparable to "how much house" you would get for only the down payment. In short, using mortgage debt wisely allows a homebuyer to get a lot more house than would be possible from the down payment alone. Something just like that happened with the companies in which Berkshire Hathaway has large investments... Their wisely used, affordable debt pushed the five-year median ROE for these holdings up to 25.1% versus 14.3% for the S&P 500. Folks, this is as clear as it gets in finance... Buffett, the king of value investing, doesn't mind buying companies with high debt loads. But he makes darn sure those companies can pay their bills. And he makes sure their management teams are capable of effectively using the capital raised by the debt. So in the end... don't shy away from debt in the markets. Just make sure the fire is under control. You don't want it to burn the house down. Good investing, Marc Gerstein Market View Major Indexes and Notable Sectors # Hld: Bullish Neutral Bearish Dow 30 +0.03% 7 20 3 S&P 500 -0.74% 79 346 72 Nasdaq -1.92% 8 68 23 Small Caps -1.98% 231 1114 525 Bonds -2.34% Financial +1.26% 10 52 0 — According to the Chaikin Power Bar, Small Cap stocks are more Bearish than Large Cap stocks. Major indexes are mixed. * * * * Top Movers Gainers [rating] NLSN +30.50% [rating] EPAM +9.92% [rating] PARA +9.66% [rating] MRNA +8.59% [rating] WRK +5.57% Losers [rating] LVS -11.89% [rating] DVN -10.15% [rating] CTRA -9.75% [rating] OGN -9.68% [rating] ENPH -7.85% * * * * Earnings Report Reporting Today Rating Before Open After Close GOCO, LFUS SMAR No earnings reporting today. Earnings Surprises [rating] COUP Coupa Software Incorporated Q4 $0.19 Beat by $0.14 [rating] MTN Vail Resorts, Inc. Q2 $5.47 Missed by $-0.19 * * * * Sector Tracker Sector movement over the last 5 days Financial +2.76% Materials +1.93% Industrials +0.53% Discretionary +0.46% Health Care -0.24% Real Estate -0.50% Communication -1.03% Information Technology -1.95% Utilities -2.03% Energy -2.34% Staples -3.58% * * * * Industry Focus Software & Services 8 95 76 Over the past 6 months, the Software & Services subsector (XSW) has underperformed the S&P 500 by -18.73%. Its Power Bar ratio, which measures future potential, is Very Weak, with more Bearish than Bullish stocks. It is currently ranked #16 of 21 subsectors. Indicative Stocks [rating] MSTR MicroStrategy Incorp [rating] AFRM Affirm Holdings, Inc [rating] PLTR Palantir Technologie * * * * Chaikin Analytics LLC is not registered as a securities broker-dealer or advisor either with the U.S. Securities and Exchange Commission or with any state securities regulatory authority. Chaikin Analytics does not recommend the purchase of any stock or advise on the suitability of any trade. The information presented is generic in nature and is not to be construed as an endorsement, recommendation, advice or any offer or solicitation to buy or sell securities or any kind, but solely as information requiring further research as to suitability, accuracy and appropriateness. Users bear sole responsibility for their own stock research and decisions. Read the full disclaimer at [(. You have received this e-mail because you subscribed to PowerFeed, published by Chaikin Analytics. To stop receiving PowerFeed daily, click to [unsubscribe](. For questions about your account or to speak with customer service, call +1 (877) 697-6783 (U.S.), 9 a.m. - 5 p.m. Eastern time or e-mail info@chaikinanalytics.com. Chaikin Analytics 201 King of Prussia Rd. Suite 650 Radnor, Pennsylvania 19087 United States +1 (877) 697-6783