A Temperature Check on “Sick Corporations”: Lessons from Napoleon Bonaparte’s failed battle in the 19th century [Wednesday: The Independent Investor]
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A Note from Miles Everson:
Welcome to today’s “The Independent Investor!”
Every Wednesday, we publish articles about basic investing tips. We want to help you strategically think about your financial decision-making and achieve true wealth in the long run.
Today, let’s go down memory lane and focus on an important part of history that happened in the 19th century.
Continue reading below to understand how the lessons from this story can apply to your investment strategy.
The Independent Investor
Napoleon Bonaparte played an important role in history.
Also known as Napoleon I, Bonaparte was the French general who revolutionized military training and organization, sponsored the Napoleonic Code, reorganized the education system, and established the long-lived French concordat with the papacy in the 19th century.
His many reforms left a lasting mark on the institutions of France and much of western Europe. He was revered during his lifetime and considered as one of history’s great heroes.
Did you know Bonaparte’s series of conquests have some interesting lessons that you can apply to your investment strategies?
Take a look at this story…
At the turn of the 19th century, Bonaparte had just invaded Egypt. This was after his resounding victory against the Austrian empire in Italy, and this time, the legendary general was seeking more glory to the east.
He convinced the politicians in Paris that sending an army to Egypt would improve France’s leverage with the Ottoman Empire in trade negotiations. The French could also plunder Egypt’s historical and scientific riches, and at the same time open a path to eventually invade British India.
In short order, though, Bonaparte found himself stuck. His navy had been defeated by the British just after the invasion started, and he was stranded. He couldn’t get more supplies from France or go back home.
So, in true Napoleonic fashion, Bonaparte and his warriors went on the offensive.
The French army marched toward Syria to take on the British-backed Ottoman army. The problem? Bonaparte’s army was facing the Middle Eastern heat and limited food… and plague was tearing through the men.
This was the last thing Bonaparte expected after coming off from his victories in Europe. He needed to keep his fighting force in the best shape possible, and that meant making a choice.
The doctors in the army decided to use their limited supplies on those soldiers they could save—ones they could bring back to their fighting form the fastest. Anyone who was too sick went to the back of the treatment line.
Despite the calculated strategy, Bonaparte lost that campaign. It was the first time he had to retreat during the Napoleonic Wars, and he did it by abandoning his army and returning to Paris alone.
According to Robert Spivey, Director of Research at Valens Research, this was the first real example of triage being used in medicine, although in a barbaric way.
… but did you know this “triage” is what some investors also use in their investment strategies nowadays?
In the investing world, a company’s credit risk gets treated in a similar way. The worse off the company, the more leery investors get and the more likely they are to pull their money and put it somewhere healthier.
Meanwhile, when companies end up with imminent credit risk, investors leave them for dead. When enough companies go bankrupt, the markets get a recession.
So, if you want to understand how high the risk of a recession is at the moment, the first question to answer is, “how many companies are graded as ‘high risk’?”
Let’s dive deeper into how much risk U.S. companies currently have. This will help you see how likely a recession is from here, and how bad it might be.
Checking the Temperature of “Sick Corporate Patients”
There are several ways Spivey and his team at Altimetry Financial Research gauge corporate health aside from looking at their Credit Cash Flow Prime (CCFP) analysis. One is by looking at how much cash companies have on hand relative to near-term obligations.
The U.S. Federal Reserve is raising interest rates to make it harder for companies to borrow more money and to refinance. It’s trying to slow down the economy.
However, if companies have enough cash on hand to meet their debt maturities, the Fed’s efforts will cool down the economy without doing serious damage.
To see what kind of shape companies are in at present, let’s look at how many have more cash than they have debt coming due in each of the next three years.
Based on the chart above, many companies scrambled to build enough cash to handle their near-term obligations from 2019 to 2021. They didn’t want a cash crunch. In 2020, 9 out of every 10 S&P 500 Index companies had more cash on hand than debt coming due in the next 12 months.
For most of the past 15 years, roughly 3 out of every 4 companies had enough cash on hand to cover the next year’s debt maturities. The number of companies that had more cash than debt maturing in the next 3 years peaked at roughly 7 out of 10.
Spivey says at present, companies aren’t holding as much cash as they did during the peak of the COVID-19 pandemic… but don’t fret! The levels are still above average.
Almost 4 out of every 5 companies have more cash than debt coming due in the next year. Those with enough cash for the next 3 years are near normal peak levels.
Is that great news?
That means the economy isn’t about to get slammed with “very sick corporate patients.”
The Fed’s actions over the past year or so have definitely hurt a lot of weaker companies. Some companies won’t be able to refinance their debt now that interest rates are high and demand is slowing down.
Nevertheless, corporate balance sheets are healthy as a whole. So, Spivey says those “sick corporations” will be fewer and further between than they normally would be as the Fed cranks up rates.
Just a head’s up: A recession is likely looming in late 2023 or early 2024 for some time… but that recession is likely to be mild. There’s nothing to worry about.
In fact, within this choppy market, there will be buying opportunities. So, as an investor, take advantage of companies that will be able to “weather the storm.”
Take note of this investing insight so you won’t end up putting your money in “very sick corporate patients!”
(This article is from The Business Builder Daily, a newsletter by The I Institute in collaboration with MBO Partners.)
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“Wednesdays: The Independent Investor”
To best understand a firm, it makes sense to know its underlying earning power.
In two of the greatest books ever written on investing, the “Intelligent Investor” by Benjamin Graham and “Security Analysis” by David Dodd and Benjamin Graham (yes, Graham authored both of these books), the term “earning power” is mentioned hundreds of times.
Despite that, it’s surprising how earning power is mentioned seldomly in literature on business strategy. If the goal of a business is wealth creation, then the performance metrics must include the earning power concept.
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