Stay Away From These Stocks

October 27, 2023

Good grief. The world is a mess.

Recession talk is back in full force… markets are getting more and more volatile by the day… and the flames of war continue to burn in the Middle East.

Meanwhile, the latest GDP report says our economy is growing… even though a ton of other economic metrics have us scratching our heads and raising our eyebrows.

Is the growth we’re seeing built atop solid rock… or quicksand?

It’s a lot to think about.

But here’s what investors need to know…

Too many businesses are running on unsustainable debt levels. They’ve bit off more than they can chew… and borrowed more than they could handle… because they got hooked during the era of rock-bottom, near-zero interest rates.

Those days are long gone.

The Fed has spent the past two years hammering the nails into their coffin. “Higher for longer” interest rates are the new normal.

But here’s what’s key…

It’s not just interest rates that have risen. So has the number of delinquencies and bankruptcies.

Now more than ever, being solvent is critically important. Companies that have an easier time paying back debt… and making interest payments… should have a clear advantage.

Frankly, I don’t want to invest in a business that can’t pay its bills. Do you?

That’s just common sense. But these days, common sense seems to elude most folks.

So let’s forget common sense for a moment… and look at some data.

I took all of the companies in the S&P Composite 1500 Index and ranked them by earnings before interest and taxes (EBIT) divided by interest.

The higher their interest coverage ratio is (which shows how well they can pay the interest on their debt), the higher they rank.

For companies of a similar rank, I then looked at their average total return over the past two years… starting just prior to the beginning of the Fed’s aggressive rate hike cycle.

The results are clear…

Companies with strong interest coverage are dominating their poorly covered peers… by a long shot. We’re looking at differences in performance as wide as 40 percentage points.

In today’s high interest rate environment… this metric can tell us which stocks are getting crushed… and which ones are flourishing.

Again, it just takes a bit of common sense.

The more comfortably you can pay your bills, the better financial shape you are in.

Even if you earn a ton of money… if your costs are as high as your income… you’re just as broke as the guy next door.

If it’s true for households… then why not for big businesses?

You wouldn’t lend money to someone who’s unlikely to pay it back. You should have the same attitude toward companies.

Just look at Dish Network (DISH). Its interest coverage ratio is less than 1.0… and the stock is down a massive 65% this year.

If a company’s unlikely to generate a return on your capital, it’s not worth investing in. And if a company’s struggling to pay back its creditors, then the odds it’ll reward shareholders are awfully slim.