When financial services go wrong…
Companies taking advantage of financing sometimes make mistakes that hurt shareholders. A perfect example can be illustrated by General Electric Company (NYSE:GE)‘s past. During the financial crisis, concerns about GE Capital, the company’s financial services arm, caused an otherwise solid industrial conglomerate to lose its triple-A credit rating. It was probably even the root cause behind the company’s dividend cut. Could this scenario also happen to IBM and Ford?
IBM and Ford are much more conservative now with financing activities than General Electric Company (NYSE:GE) was before the crisis. GE Capital was, and may still be, a different story. At the time, it was invested in real-estate businesses, overseas banking, insurance operations, and all kinds of other financial endeavors. This led to much more complexity than, say, Ford leasing cars through Ford Credit. GE Capital is also a bank, not just a financing unit of the company.
It is always wise to pay attention to a company’s financing activities to ensure that they are not being utilized for risky behavior. Luckily, General Electric has recognized the need to “trim the fat” on GE Capital by selling off, or planning to sell-off, non-core parts of it. GE Capital itself is so big that it would be the fifth-largest bank in the U.S. if it were a separate institution. It is also still incredibly profitable in good times– contributing 47% of its parent company’s operating earnings in the first quarter.
The bottom line
Pre-financial crisis General Electric is a classic example of when risky financial aspects of an otherwise solid company can crater shares. Ford and IBM, however, are using financing responsibly. Both companies look much stronger when their true debt situation is fully grasped.
Regular and financing debt are usually separated on the balance sheet and in earnings reports. Subtracting financing from total debt will give you the amount of regular debt. If you’re looking into a stock that carries an abnormal amount of debt, check first to see whether that debt stems from profitable financing activities before you cast it off as a troubled company.
High debt levels can be deceptive. Now you know that they aren’t always detrimental, either.
The article Don’t Be Deceived by Misunderstood Debt Levels originally appeared on Fool.com and is written by Joseph Harry.
Joseph Harry owns shares of International Business Machines (NYSE:IBM)., General Electric Company, and Ford. The Motley Fool recommends Ford. The Motley Fool owns shares of Ford, General Electric Company, and International Business Machines. Joseph is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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