Look for stocks with this balance sheet trait to outperform in the coming recovery

This bear market will produce the great companies of the next decade. Will you be able to identify them?

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This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.

Bear markets can often feel like doomsday events for investors, but there's good that comes out of these healthy downturns. Bear markets separate the wheat from the chaff.

In other words, they make apparent the companies that are worthy of investor dollars, as well as those that probably should have never gone public in the first place.

There's one very distinguishable trait that nearly all bear market winners have in common: Healthy cash levels on their balance sheets.

Having a lot of cash allows strong companies to take advantage of cheap valuations in the form of acquisitions.

While cash-poor companies struggle to keep their boats afloat, those with strong balance sheets can bolster their businesses by buying out their competitors or acquiring entire new product lines.

How to identify a cash-rich balance sheet

If diving deep into financial statements isn't your thing, then you're in luck, because identifying a strong cash position is very easy.

Simply add the cash and cash equivalents and short-term investments/securities lines on the balance sheet, and you'll arrive at the company's total cash.

Comparing this number to the current liabilities (expenses the company will pay in the next 12 months) gives you a good idea of how cash-rich the business is.

Take Shopify (NYSE: SHOP), for example. The company has nearly $7 billion in cash and only $700 million in current liabilities. Not only does that tell us the company is more than capable of self-funding its operations, it also has plenty of cash to deploy in this bear market.

Winners from past bear markets

Some of the most prolific and profitable companies today were built on tremendous acquisitions made when the market was selling off.

Had these companies not had adequate cash reserves during these periods, they would likely not be nearly as prominent as they are today.

Let's take a look at some examples:

CompanyAcquisitionYearPrice paidCurrent annual revenue from acquisition
Disney (NYSE: DIS)Marvel2009$4 billion~ $2.8 billion*
Alphabet (NASDAQ: GOOG)YouTube2006$1.65 billion$28 billion
Meta (NASDAQ: META)Instagram2012$1 billion$47 billion

Data source: Public company filings and box office data. Table by author. * Does not account for revenue from Disney Plus subscribers.

In the wake of the Great Financial Crisis, Disney made one of the most important acquisitions in film history, buying up a relatively obscure comic book company called Marvel. As we all know now, the Marvel Cinematic Universe is one of the world's most successful franchises, bringing in a whopping $2.8 billion in annual revenue for Disney.

That number is pretty astounding, considering the company only paid $4 billion to acquire Marvel. And the real annual revenue is likely much higher, since it's difficult to estimate how much of Disney's streaming revenue is due to its Marvel titles.

If the Marvel acquisition looks impressive, then the YouTube and Instagram buyouts are downright silly. Alphabet paid just $1.65 billion for YouTube in the years following the dot-com bubble, and today it accounts for $28 billion in revenue for the Google parent company.

Meta (at the time Facebook) might have made the greatest acquisition of all time when it bought Instagram for a ridiculously cheap price of $1 billion in 2012. Today, Instagram accounts for roughly 44% of Meta's total revenue. To call this acquisition a home run would be the understatement of the century.

All three companies owe a meaningful amount of their success to the high-quality acquisitions made in past down markets.

Cash-rich companies are uniquely positioned to prosper in recoveries

The examples above highlight just how important it is to have cash in bear markets. An abundance of capital not only protects the business from bankruptcy, it gives the company the ability to buy up cheap assets to strengthen its competitive advantages.

Very few acquisitions will be as dramatically important as the examples above, but the discounts created by bear markets can turn average buyouts into meaningful sources of revenue and income in the future.

This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.

Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Randi Zuckerberg, a former director of market development and spokeswoman for Facebook and sister to Meta Platforms CEO Mark Zuckerberg, is a member of The Motley Fool's board of directors. Mark Blank has positions in Shopify and Walt Disney. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has positions in and has recommended Alphabet (A shares), Alphabet (C shares), Meta Platforms, Inc., Shopify, and Walt Disney. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has recommended the following options: long January 2023 $1,140 calls on Shopify, long January 2024 $145 calls on Walt Disney, short January 2023 $1,160 calls on Shopify, and short January 2024 $155 calls on Walt Disney. The Motley Fool Australia has recommended Alphabet (A shares), Alphabet (C shares), Meta Platforms, Inc., and Walt Disney. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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