While most investors are focused on sales growth & margins, they would be well served to further consider the strength of a company’s balance sheet. We look at BlackRock’s financial condition as an illustrative point.
Commentary
- Equity and credit research are fundamentally different in that stock investors are focused on assessing the upside while bond investors are focused on protecting from the downside. This reflects that bonds are typically used to provide a fixed income stream more so than capital appreciation.
- Credit research is primarily focused on a company’s asset quality and equity cushion. These attributes grow in importance relative to a company’s leverage level, and this reflects the fact that a highly indebted company is dependent upon the willingness of its lenders to continue funding its operations. If the banks or bondholders start to question the balance sheet quality of a highly leveraged company (and/or its ability to generate cash flow), the company can become insolvent very quickly.
- As an illustrative point, we outline BlackRock, Inc.’s balance sheet below. This well-known asset manager oversees $9 trillion in investments on behalf of its investors and has total assets of $121B on its own balance sheet. While it seems that a $38B equity position provides a solid cushion for its asset position (representing 31% of the total), a more accurate assessment is provided by subtracting $33.6B in intangible assets & goodwill to calculate BlackRock’s $4.1B tangible equity position. With $65B in securities on its balance sheet, it is apparent that a -10% decline in the market could wipe out BlackRock’s tangible equity position. Even though BlackRock is commonly thought of as a bedrock of the capital markets, a careful look at its balance sheet reveals a risk that is important for both stock & debt investors to consider.
