Borrowing from Peter to Pay Paul

As credit markets continue to tighten, companies that have used financial engineering to boost earnings per share (EPS) may be particularly hard hit. As shown, since the end of the Great Recession, management teams increasingly turned to debt as they aggressively bought back company stock. The move allowed CEOs to boost results even when sales were flat by reducing the number of shares that have a claim on each dollar of revenue.

With rates moving higher and signs emerging that investors are souring on leveraged balance sheets, the shortcut to EPS growth may be turning into a dead end. Year-to-date*, businesses in the Russell 3000® Index with the most debt have lagged the broader benchmark and have been among the worst performers.

If this trend continues, we believe businesses with low or no debt that have the ability to improve earnings through sales growth will be poised to outperform in the coming quarters.

Disclosure:

*As of 2/29/2016

Past performance does not guarantee future results.

The statements and opinions expressed in this article are those of the presenter(s). Any discussion of investments and investment strategies represents the presenter’s views as of the date created and are subject to change without notice. The opinions expressed are for general information only and are not intended to provide specific advice or recommendations for any individual. Any forecasts may not prove to be true. Economic predictions are based on estimates and are subject to change.

Investing involves risk, including the potential loss of principal. There is no guarantee that a particular investment strategy will be successful. Value investments are subject to the risk their intrinsic value may not be recognized by the broad market.

Definitions: Earnings Per Share: is the portion of a company’s profit allocated to each outstanding share of common stock. Russell 3000® Index: is a market capitalization weighted equity index maintained by the Russell Investment Group that seeks to be a benchmark of the entire U.S. stock market and encompasses the 3,000 largest U.S.-traded stocks, in which the underlying companies are all incorporated in the U.S. Russell Investment Group is the source and owner of the trademarks, service marks and copyrights related to the Russell Indexes. Russell® is a trademark of the Frank Russell Investment Group. All indices are unmanaged. It is not possible to invest directly in an index.

CFA is a trademark owned by the CFA Institute.

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