Your currency is the credit rating of your country

Last week we published a discussion of the S&P's lowered outlook for the ability of the US to sustain a AAA credit rating. We noted that the silver lining to the debate over the creditworthiness of the US is the fact that at least we are having the debate. Perhaps the fact that this problem has become front-page news is a good sign. The dark cloud that goes along with that silver lining, however, is the fact that the government's balance sheet has probably never been worse (and a balance sheet, as any credit analyst knows, is a critical indicator of anyone's creditworthiness).

We don't need credit ratings agencies such as Standard & Poor's to tell us that the creditworthiness of the US government is at an all-time low. The late Dick Taylor used to have a saying that "Your currency is the credit rating of your country." As economist Scott Grannis explained yesterday, the value of the US dollar has hit a new all-time low, and he shows graphs illustrating the dollar's additional decline during Ben Bernanke's press conference.

Ironically, the budgetary woes of the US federal government coincide with a period of general financial strength and stability for many US corporations. Corporations that survived the government-induced financial shocks of 2007-2009 and 2000-2002 have learned to keep the debt side of their balance sheets under control and in recent years have held large amounts of cash on hand for emergencies.

Some pundits have claimed that those who say that US corporations are flush with cash are only looking at one side of the balance sheet. For instance, last fall financial journalist Brett Arends wrote that "American companies are not in robust financial shape. Federal Reserve data show that their debts have been rising, not falling. By some measures, they are now more leveraged than at any time since the Great Depression. "

Because of all this leverage, Arends said, "companies only have 'record amounts of cash' in the way that Subprime Suzy was flush with cash after that big refi back in 2005. So long as you don't look at the liabilities, the picture looks great. Hey, why not buy a Jacuzzi?"

But this claim is simply not true. He supports his assertions by looking at net debt versus assets for US nonfinancial companies, but excludes assets held overseas. Furthermore, data about net debt and net assets of every company in the aggregate tells us nothing about the strength of individual company balance sheets, which is what investors should be looking at in the first place.

If we look at some of the Taylor Frigon growth companies that we have highlighted over the years in our "Have you heard of this company?" series, we can see that their balance sheets typically contain more than sufficient assets on hand to cover any long-term debt (see table below). We would also note that these corporations are typically increasing their earnings at a very healthy rate each year, which makes comparing corporations to individuals who finance hot tubs with a "big refi back in 2005" a very misleading analogy.

EZCH cash and cash equivalents: $65 million. long-term debt: zero.

CHRW cash and cash equivalents: $399 million. long-term debt: zero.

IIVI cash and cash equivalents: $119 million. long-term debt: $4 million.

HITT cash and cash equivalents: $295 million. long-term debt: zero.

DLB cash and cash equivalents: $434 million. long-term debt: zero.

TSCO cash and cash equivalents: $257 million. long-term debt: $1 million.

RMD cash and cash equivalents: $540 million. long-term debt: zero.

Some may accuse us of "cherry-picking" only the best companies, but that's exactly what we do when we select businesses to include in an investment portfolio, and what we suggest that most investors should do as well. Besides, for this illustration we simply looked at those companies from our Core Growth Strategy that we have mentioned before in this blog.*

And let's not forget Apple, which recently released absolutely jaw-dropping earnings and whose long-term stock performance we compared to the long-term price increase in gold in an earlier post about the weakness of the dollar against gold. Their corporate balance sheet has about $16 billion in cash and cash equivalents, and long-term debt of zero.*

Rarely has the split between the financial soundness of the public sector and the financial soundness of the leading companies of the private sector been so great. Private companies are driving amazing innovation in many areas, at the same time that government spending has reached completely unsustainable levels.

Our recommendation for the government would be to enact government reforms that allow continued growth and innovation (including lower tax rates, less byzantine regulation, and a strong and stable dollar) while tackling the entitlements that are sinking the federal budget and the budgets of many states.

Meanwhile, for individual investors, we would recommend looking for innovative growing companies with sound balance sheets as places to put their investment capital. After all, while the dollars that the federal government issues hit an all-time low, the creditworthiness of many companies could hardly be better. While they don't issue dollars that reflect the state of their balance sheets, they do issue securities which can enable investors to participate in the benefits of their prudential budgetary management.

* At the time of publication, the principals of Taylor Frigon Capital Management owned securities issued by EZchip Semiconductor (EZCH), CH Robinson Worldwide (CHRW), II-VI Inc. (IIVI), Hittite Microwave (HITT), Dolby (DLB), Tractor Supply Co. (TSCO), Apple (AAPL) and ResMed (RMD).

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