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In his 1987 annual letter to shareholders, Warren Buffett said that "Good business or investment decisions will eventually produce quite satisfactory economic results, with no aid from leverage." In other words, the best companies don't need to finance their ongoing operations with debt; they can generate the cash they need internally. And Buffett isn't the only famous investor to pay careful attention to a company's debt burden. Peter Lynch of Fidelity, John Neff of Vanguard and even the father of value investing himself, Benjamin Graham, all tended to focus their attention on firms with relatively low debt burdens. Of course, there is nothing inherently wrong with debt. After all, outside of internally generated funds, publicly-traded firms only have two basic ways of financing their activities -- issuing debt or selling additional shares of stock to the public. Selling shares in a secondary offering increases a firm's outstanding share count, which dilutes earnings per share (EPS) -- total earnings divided by total shares outstanding. Thus, issuing stock dilutes the ownership stake of existing shareowners and can have a negative impact on the price of the stock. In contrast, bonds and other debt holders don't actually own a piece of the business. Thus, unless a company defaults on its repayment obligations or goes into bankruptcy, bondholders have no claims on a firm's earnings stream other than interest payments. Therefore, issuing debt isn't dilutive. But debt can certainly be a problem. Companies have to keep paying interest and repaying principal whether their underlying business is booming or slumping. Thus, during economic slowdowns, firms with high debt burdens are more vulnerable to financial problems. If earnings and cash flows are no longer sufficient to meet debt obligations, then weak firms can be forced into bankruptcy. And even for stronger firms, hefty interest obligations can still chip away at earnings and reduce the amount of cash that might otherwise be available for dividends, buybacks or other needs. Moreover, the credit markets aren't always easy to tap. Last year, credit was widely available -- even firms with a limited operating history or high existing debt burdens could issue bonds or take on bank loans at attractive interest rates. Demand for high-yield or "junk" debt (riskier bonds deemed below investment grade by major ratings agencies like S&P and Moody's) was strong and interest rates on such debt were near historic lows. But credit markets can turn on a dime. Over the past month, for example, demand for high-yield debt has weakened and a handful of major deals (including the Chrysler and Alliance Boots takeovers) are now in jeopardy. Meanwhile, other companies like online travel agent Expedia (Nasdaq: EXPE) have had to scale back stock repurchase plans because of trouble obtaining favorable financing terms. Sometimes, investors' appetite for riskier debt can disappear seemingly overnight. Therefore, firms that are reliant on bond issues to fund their operations can get into real financial troubles when credit markets sour. High or rising debt burdens can also be a signal of deteriorating financial condition. Issuing new debt to fund an important acquisition or build a new facility can be accretive to shareholders. But if a firm is constantly issuing new debt or drawing on its credit lines, then it might be a sign that the company isn't generating enough internal cash to fund its ongoing operations. Fortunately, the opposite can also be true. In other words, when a firm is steadily paying down its debt, it could well be a sign of a strengthening core business. By definition, companies that are paying down debt must be generating enough free cash flow to fund ongoing business activities, meet current debt obligations and pay back principal. By reducing debt, companies increase their financial flexibility and lower the risk of a credit crunch in the event of a business slowdown. So how exactly do we measure a firm's debt load? One of the more common and popular measures is the debt-to-equity (D/E) ratio. D/E can be easily calculated by simply dividing a particular company's total debt load by its shareholder's equity. Shareholder's equity is an accounting measure that represents a firm's total assets minus total liabilities. There is no hard-and-fast rule for what constitutes an acceptable D/E ratio. Some industries, such as oil and gas pipelines, generate a great deal of steady, non-cyclical free cash flow and can carry a higher debt burden. Meanwhile, more cyclical firms that are susceptible to sharp business slowdowns and big swings in cash flows probably can't hold as much debt -- the risk is just too great that a business downturn could lead to default. As a rule of thumb, it's usually best to look for non-financial firms that carry D/E ratios of no more than 50% -- and preferably less than 25%. With these points in mind, my staff and I recently searched for firms that are steadily paying down their debt burdens and cleaning up their balance sheets. In the process, we looked for firms that met the following criteria: 
Current D/E ratio below 25%
D/E ratio fell in each of the past four fiscal years
Positive 3-Year Revenue Growth
Market capitalization of greater than $150 millionAfter running these criteria through StreetAuthority's advanced screening software, we came up with the following list of companies... Important Note: Throughout the remainder of this article, Editor Paul Tracy and our research staff provide the names of 17 companies that meet the criteria listed above. However, in order to view the remainder of this article, you'll need to subscribe to our premium newsletter -- Market Advisor. After you subscribe you'll receive immediate access to this full article, as well as our monthly Market Advisor newsletter and a host of additional premium content. Please visit one of the following links to continue...
Paul Tracy founded StreetAuthority and became Chief Investment Strategist in 2001. Prior to that he spent several years as Managing Editor at a multi-million dollar financial publishing firm with over 150,000 subscribers. In addition to his role as managing editor and lead financial writer, he was also responsible for equity research and managing a team of seasoned professional financial writers, researchers and market commentators. Paul's previous experience includes a position at Robert W. Baird & Co.'s full-service brokerage operations as well as economic research work on a Money and Banking project funded by the National Bureau of Economic Research. He has also spent time doing outside consulting and research for the University of Virginia, has appeared as a guest expert on several prominent financial radio shows, and has been a featured speaker at various investment conferences across the U.S. Paul graduated with a B.S.
in Finance and Management from the McIntire School of Commerce at the
University of Virginia.
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