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Battening Down the Portfolios

By Richard Stavros on January 28, 2016

Times are tough. So much so the International Monetary Fund and the World Bank’s economists have lowered global growth forecasts. And Wednesday the Federal Reserve said it was putting a hold on rate hikes given those global growth concerns.

The signs of strain are showing in a number of places beyond stock markets. For example, default rates for U.S. corporate bonds have overtaken default rates for emerging markets corporates, according to new data published by Bank of America Merrill Lynch.

Still, we are hopeful that gains in U.S. employment and low oil prices will boost consumer spending and offset global weakness.

The Banker’s Umbrella

If the global economy continues to worsen, the first thing that will quickly disappear is credit. As Mark Twain said, “A banker is a fellow who lends you his umbrella when the sun is shining, but wants it back the minute it begins to rain.”

If markets turn for the worst and credit tightens, only those firms with the strongest balance sheets, pricing power and economies of scale will weather the economic storm. Finding those firms is the central goal at Global Income Edge.  

Many investors often fail to take into account the disastrous impact of tightening credit conditions on businesses, when demand growth starts to stall. That’s why I constantly test our portfolio companies’ profitability, as well as their use of debt or leverage and how they might be affected by worsening conditions.

Here is a brief review of various analyses that I conduct on our portfolio holdings:

GIE Early Warning System This is a proprietary financial model I developed for income investments. It breaks a company’s return on equity (ROE) into its individual components, which makes analyzing what’s actually driving growth easier. In addition to identifying promising investments, this system alerts us to declining margins and rising leverage.

Current Ratio The current ratio is a liquidity ratio that measures a company’s ability to pay short-term and long-term obligations. To gauge this ability, the current ratio considers the total assets of a company (both liquid and illiquid) relative to that company’s total liabilities.

Quick Ratio The quick ratio is an indicator of a company’s short-term liquidity. The quick ratio measures a company’s ability to meet its short-term obligations with its most liquid assets.

Levered Cash Flows The free cash flow that remains after a company has paid its obligations on its debt. The levered cash flow represents the amount of cash left over for stockholders and for investment after all obligations are covered. The levered cash flow can be negative while the operating cash flow is positive if the amount of cash paid to cover obligations exceeds the cash that comes from operations.

 


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