Look for stocks with this balance sheet trait to outperform in the coming recovery

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Bear markets can often feel like doomsday events for investors, but there is some good that comes out of these healthy downturns. Bear markets separate the wheat from the chaff.

In other words, they highlight companies that deserve investors’ money, as well as companies that probably should never have gone public in the first place.

There is one very distinctive trait that almost all bear market winners have in common: healthy levels of liquidity on their balance sheets.

Image source: Getty Images.

Having plenty of cash allows strong companies to take advantage of cheap valuations in the form of acquisitions. While cash-poor companies struggle to keep their boats afloat, those with strong balance sheets can bolster their businesses by buying out competitors or acquiring new product lines.

How to identify a cash-rich balance sheet

If diving into financial statements isn’t your thing, then you’re in luck, because identifying a strong cash position is very easy.

Simply add cash and cash equivalents and short-term investments/securities lines to the balance sheet, and you’ll arrive at the company’s total cash.

Cup of coffee and glasses sitting on a financial document.

Image source: Getty Images.

Comparing this number with current liabilities (expenses the business will pay over the next 12 months) gives you a good idea of ​​the cash wealth of the business.

Take Shopify (STORE 17.34%), for example. The company has nearly $7 billion in cash and only $700 million in short-term liabilities. Not only does this tell us that the company is more than able to self-fund its operations, but it also has plenty of cash to deploy in this bear market.

Winners of past bear markets

Some of today’s most prolific and profitable businesses were built on huge acquisitions made when the market was down.

If these companies had not had sufficient cash reserves during these periods, they probably would not have been as large as they are today.

Let’s take a look at some examples:

Company

Acquisition

Year

Price paid

Current annual revenue from acquisition

disney (SAY -0.18%)

wonder

2009

$4 billion

~$2.8 billion*

Alphabet (GOOG -2.34%)

Youtube

2006

$1.65 billion

$28 billion

Meta (META -24.56%)

instagram

2012

$1 billion

$47 billion

Source of data: documents filed by public companies and box office data. Table by author. * Does not include income from Disney Plus subscribers..

In the wake of the Great Financial Crisis, Disney made one of the biggest acquisitions in movie history, buying up a relatively obscure comic book company called Marvel. As we all know by now, the Marvel Cinematic Universe is one of the most successful franchises in the world, generating a whopping $2.8 billion in annual revenue for Disney.

That number is pretty amazing, considering the company only paid $4 billion to acquire Marvel. And the actual annual revenue is likely much higher, as it’s hard to estimate how much of Disney’s streaming revenue comes from its Marvel titles.

If the Marvel acquisition sounds impressive, then the YouTube and Instagram takeovers are downright silly. Alphabet paid just $1.65 billion for YouTube in the years after the dot-com bubble, and today it accounts for $28 billion in revenue for Google’s parent company.

Meta (then Facebook) made perhaps the biggest acquisition of all time when it bought Instagram for a ridiculously low price of $1 billion in 2012. Today, Instagram accounts for around 44% of total revenue from Meta. To call this acquisition a home run would be the understatement of the century.

All three companies owe much of their success to high-quality acquisitions made in past bear markets.

Cash-rich companies are uniquely positioned to thrive in recoveries

The examples above show how important it is to have liquidity in bear markets. An abundance of capital not only protects the company from bankruptcy, but also gives it the opportunity to buy cheap assets to strengthen its competitive advantages.

Very few acquisitions will be as large as the examples above, but the discounts created by bear markets can turn average buybacks into significant sources of income and income in the future.

Suzanne Frey, an executive at Alphabet, is a board member of The Motley Fool. Randi Zuckerberg, former director of market development and spokesperson for Facebook and sister of Meta Platforms CEO Mark Zuckerberg, is a board member of The Motley Fool. Mark Blank holds positions at Shopify and Walt Disney. The Motley Fool owns and recommends Alphabet (A shares), Alphabet (C shares), Meta Platforms, Inc., Shopify and Walt Disney. The Motley Fool recommends the following options: January 2023 Long Calls at $1,140 on Shopify, January 2024 Long Calls at $145 on Walt Disney, January 2023 Short Calls at $1,160 on Shopify, and January Short Calls 2024 at $155 on Walt Disney. The Motley Fool has a disclosure policy.

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