As you search for winning stocks, don't forget to check out their long-term debt levels.
IBD doesn't give a specific debt-to-equity level that means danger. Just keep in mind that lower is better and some other key points that we'll review here.
Lower debt levels are better for a simple reason: They're more manageable. A highly leveraged company might end up earning too little to meet its debt obligations due more than one year away, leading to losses and even potential bankruptcy.
Remember that you'll see different ratios that can explain a company's debt. You might see a cash flow-to-debt ratio, for example.
Be aware that some firms might want to emphasize the ratio that makes them look the best.
IBD is generally consistent in looking at just one ratio: the long-term debt to stockholders' equity. One place where you can find this figure is within the Stock Checkup feature at Investors.com, IBD's website.
Don't Become Fanatical You don't want to become fanatical in avoiding companies with sizable debt.
Some sectors, like telecom infrastructure and energy, are simply prone to using lots of debt. Some of the market's leading stocks in recent years were far from debt-free, but this didn't hold them back from making big advances.
Concho Resources (CXO) is one example. The Midland, Texas-based oil and gas explorer's debt-to-equity ratio stood at 63% at the end of 2009, but the stock still nearly doubled in 2010.
TransDigm Group (TDG) provides another example. The Cleveland-based aircraft components maker sported an eye-popping debt-to-equity ratio of 299% at the end of 2010. A major reason: TransDigm is acquisitive. Even so, TransDigm's shares scored a solid gain of 33% in 2011.
At the same time, you can't get everything you need from the debt-to-equity ratio.
It's also smart to look at a company's regulatory filings to see if it discloses any off-balance-sheet liabilities, which are not incorporated into shareholders' equity. Retailers are known for doing this with store lease obligations. Financial firms are infamous for being creative in this area.
Off The Balance Sheet You can see off-balance-sheet liabilities in sectors where you might not expect it. Take Netflix (NFLX), the DVD-rental-by-mail pioneer that's now focusing on its streaming video business.
One challenge for the company is the cost of each TV show or movie that it beams over the Internet to a user.
As you might expect, the Silicon Valley company has made a number of deals to get this content. What you might not expect is that these deals aren't all accounted for on Netflix's balance sheet as liabilities.
With its 10-K filed with the SEC on Feb. 1, Netflix declared $3.2 billion in total liabilities. But deeper in the 10-K — on page 57 — you'll find something else worth knowing.
The report says: "The Company had $5.6 billion and $4.8 billion of obligations at December 31, 2012 and December 31, 2011, respectively, including agreements to license streaming content that represent current or long-term liabilities or that are not reflected on the Consolidated Balance Sheets because they do not meet content library asset recognition criteria."