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Financial strength test
The rule
Before you buy, check the company can survive a bad year. Enough cash to cover its dues, and not too much loan.
Where it flips
But a super-safe company can also sit on idle cash that earns nothing. The fix is to want enough strength to survive any year, without praising cash hoarded for no reason.
A company gets through hard years on a strong balance sheet, not a nice story. Graham's careful check wants two things. First, plenty of short-term assets, comfortably more than its short-term dues. Second, low debt. Then a bad patch is survived, not deadly. Strength comes first. Cleverness comes second.
A worked example
Two firms earn the same. One holds twice as much in short-term assets as its short-term dues, with little debt. The other is short on cash and full of loans. When sales dip one year, the first coasts through and the second must borrow at the worst time. [illustrative]
How to spot it
- ·short-term assets well above short-term dues
- ·only a little long-term loan
- ·can survive a bad year without begging for money
Benjamin Graham · The Intelligent Investor