Leverage loved in equities spurs broadest rally since 1995

Altman Rankings

The baskets ranking S&P 500 companies by balance sheets are drawn by Goldman Sachs using criteria developed by New York University Professor of Finance Edward I. Altman in the 1960s. Altman tried to predict probabilities of corporate default by combining income and financial ratios that include working capital, assets, sales, earnings and equity.

Companies in the weaker-finance group -- from Constellation Brands Inc. to Tenet Healthcare Corp. -- have median debt equaling 0.77 times equity and 2.67 times earnings before interest, taxes, depreciation and amortization, according to Bloomberg data.

Debt is 0.12 times equity and 0.35 times Ebitda for the strong-balance-sheet index, the data show. That group includes companies form Exxon Mobil Corp., the largest U.S. oil company, to Urban Outfitters Inc., a Philadelphia-based retailer.

Fed Options

Companies with more solvency risk are beating the market in part because Fed policy gives them more options for raising money. The central bank has pumped $2.3 trillion of stimulus into the economy and held the benchmark lending rate near zero% for more than four years.

More than 380 speculative-grade borrowers, with credit ratings below Baa3 by Moody’s Investors Service and BBB- at S&P, have raised $158.3 billion through bond sales in the U.S. this year, compared with $130.5 billion by this time in 2012, data compiled by Bloomberg show. Last year’s total of $358.9 billion in junk debt set a record.

Yields on junk bonds dropped to 5.3% from 8.2% in June 2012, according to Barclays Plc indexes. That’s the lowest rate compared with AAA-rated corporate debt since 2007, the data show. Moody’s said May 8 that 12-month default rates among the least creditworthy companies worldwide reached 2.6% in April, down from almost 8% in May 2010.

Debt Refinanced

Shares of S&P 500 companies rated speculative grade by S&P have climbed 24% on average in 2013, compared with 18% for those with investment grades, according to data compiled by Bloomberg. Dallas-based Tenet has jumped 41% as the third-largest for-profit U.S. hospital chain refinanced debt at half the cost it paid to borrow in the past.

“It has become much cheaper for companies with below-grade ratings to borrow, relative to their stronger peers,” said Adrian van Tiggelen, a senior investment specialist at ING Investment Management in The Hague, which oversees $345 billion. “It has become more favorable for companies with a weaker balance sheet. They are in a much better environment.”

The rally has made the higher-debt group more expensive. Those companies trade at 20.4 times projected adjusted earnings, according to Bloomberg data, compared with a ratio of 18.8 times for less-risky corporations. The 8.9% premium is the most since estimated profit ratios start for the baskets in 2011.

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