Most investing stories focus on company earnings. How much a company can earn in the future. How much a company has earned in the past. What value (in the form of a price to earnings ratio) the market should put on those earnings. Today we’re going to change tack and focus on balance sheets instead.

Earnings come from a company’s income statement, a document showing the firm’s revenue and profits (or losses) generated over a period. By contrast, a balance sheet shows a company’s financial position – what it owns and what it owes on a certain date.

A strong balance sheet can give a company strategic flexibility. It can also reduce downside risk and make a company’s stock more attractive. I’ll cover a few reasons for this soon. But first let’s define what I mean by a strong balance sheet.

What makes a balance sheet sound?

Instead of asking what we’d like to see on a balance sheet, let’s use Charlie Munger’s inversion technique and ask what we don’t want to see.

The main thing you don’t want to see is an unsustainable level of debt. By unsustainable, I mean a level of debt that is too high relative to the company’s cash flow or the nature of its industry. Keep in mind that most successful companies can sustain some debt, and this can help them grow faster than using equity financing alone.

If a company carries too much debt, a downturn in business could mean they start struggling to keep up with interest and debt repayments. In extreme cases, it could lead to bankruptcy. But in almost every case, it will reduce the flexibility management has to create value for shareholders.

They might have to cut back on investments they need to make in the business. They might not be able to make an attractive acquisition during an industry downturn. Et cetera. What we’re looking for, then, is an absence of liabilities that could threaten the company’s survival or reduce management’s ability to act strategically. The famous value investor Marty Whitman used to talk about seeking companies that are ‘eminently creditworthy’.

Why I love strong balance sheets

My basic investment approach is to buy long-term positions in good businesses that are out of favour due to short-term pressures. Not all of my holdings have flawless balance sheets. But I view a healthy balance sheet as a big positive for three reasons.

  1. A healthy financial position increases the chances a company will make it through the rough patch they are currently in.
  2. It also gives a company the flexibility to keep investing in growth while competitors are pulling back. For example, by acquiring one of these competitors at a knock-down price.
  3. On the flip side, a healthy balance sheet could make my investment attractive to acquirers. This is because they would be able to borrow more to fund the deal. I might not actually want the company to be taken over, but it does increase the number of ways I can win.

3 ASX companies with sound balance sheets

Before we get onto the shares, here is a quick explainer of some terms you might see used:

  • Net debt: Total debt minus cash and cash equivalents. This adjusts a company’s borrowings for how much cash it has to hand. If a company has more cash than debt, this will be negative and is called a “net cash” position.
  • EBITDA: Earnings before interest, tax, depreciation, and amortisation. This is often used as a measure of how much cash a company can direct to servicing debt each year.
  • Net Debt to EBITDA: A ratio comparing net debt to cash available to service debt. In essence, this ratio tells you how quickly (in years) a company could pay off all debt using earnings.

Deterra Royalties (DRR)

Deterra Royalties was spun out by Iluka Resources in 2020. Its major asset is a royalty agreement covering Western Australia’s Mining Area C, which serves as the core of BHP’s iron ore operations.

Deterra does not stump up cash for operating expenses like a miner does. Instead, it simply watches the royalty cheques come in. This makes it highly cash generative business where the vast majority of revenue flows straight through to the bottom line.

The acquisition of Trident Royalties in 2024 resulted in net debt of $310 million as of the end of 2024. At less than two times Deterra’s 2024 EBIDTA, this is a level of indebtedness that our analyst Jon Mills is comfortable with. The company has also cut its dividend to divert more cash to paying the debt down.

Despite the Trident acquisition, which brought precious metal and lithium royalty and streaming agreements into the mix, Deterra is still very much all about MAC royalty for now. And, in turn, its earnings prospects will be shaped mostly by 1) prevailing iron ore prices and 2) BHP’s production in MAC.

Jon’s Fair Value estimate for Deterra assumes an average iron ore price of USD 95 per ton from 2025-2027, based on recent futures curve prices, and a midcycle price of USD 72 per ton based on his estimate of iron ore’s marginal cost of production.

His midcycle iron ore price forecast is a lot lower than recent prices of around USD 105 per ton, but even then he thinks that Deterra offers value for long-term investors. At a recent market price of $3.65, the company traded around 15% below Jon’s Fair Value estimate.

You can learn more about Deterra in this edition of Ask the analyst from January 2025.

Block (XYZ)

Block is a financial technology firm that owns Square, Cash App, and Afterpay. It has an ASX listing thanks to its all-stock deal to buy the latter business in 2022.

Debt shouldn’t pose much of a worry for those assessing Block’s balance sheet. After all, the company boasts a hefty net cash position, with over USD 9 billion in cash and equivalents (as of December 2024) compared to total borrowings of around USD 6 billion.

Our analyst Brett Horn thinks Block can grow its revenues at an average of 10% per year over the next decade, with increased monetisation of Cash App playing a key role in that. He also expects Block to keep more of its sales as profit, thanks in part to the highly scalable nature of payments processing. By the end of his decade forecast period, he thinks Block’s operating profit margin can climb to 10% from 4% in 2024.

These forecasts underpin Horn’s USD 126 Fair Value estimate per Block share. This corresponds to an AUD value of around $197 for the ASX listed securities, which is roughly double the current price of AUD 60. However, Horn admits that there are a broad range of potential outcomes.

For one, Cash App operates in a fast-growing niche where it is hard to say with certainty who the long-term winners will be. Meanwhile, Block also has outsized exposure to weakness in the economy through Square’s core customer base of small business merchants.

ResMed (RMD)

ResMed is one of two companies that dominate the global market for sleep apnea treatment devices. This is a market with plenty of room for growth, says our analyst Shane Ponraj, with roughly 80% of sleep apnea cases in developed countries currently going untreated.

As I showed in this article on the company’s capital allocation, ResMed has a history of borrowing to fund acquisitions before using big chunks of its free cash flow to return to a net-cash or near net-cash position rather quickly.

As of March 31 2025, ResMed had a net cash position of USD 260 million. Combine this with the highly cash generative nature of its business and relatively low revenue cyclicality, and Shane thinks the company is in an exceptionally strong financial position.

Shane’s $43 fair value for the ASX listed CDIs bakes in average annual revenue growth of 8% for the next five years and operating profit margins hitting 35% by 2029. These estimates are underpinned by ResMed’s strong position in what he sees as a growing market subject to misplaced doubts about the impact of GLP-1 drugs on demand.

His Narrow Moat rating for ResMed stems from switching costs and intangible assets. Physicians trained on ResMed’s devices and software face a learning curve if they were to switch provider, while the firm’s 8000+ granted or pending patents hint at the extent of its research and development activity. ResMed’s brand has also consistently justified a price premium over its peers.

Remember: Before you get to choosing investments, we recommend you form a deliberate investing strategy. You can read more about how to form your strategy here.

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Terms used in this article

Star Rating: Our one- to five-star ratings are guideposts to a broad audience and individuals must consider their own specific investment goals, risk tolerance, and several other factors. A five-star rating means our analysts think the current market price likely represents an excessively pessimistic outlook and that beyond fair risk-adjusted returns are likely over a long timeframe. A one-star rating means our analysts think the market is pricing in an excessively optimistic outlook, limiting upside potential and leaving the investor exposed to capital loss.

Fair Value: Morningstar’s Fair Value estimate results from a detailed projection of a company’s future cash flows, resulting from our analysts’ independent primary research. Price To Fair Value measures the current market price against estimated Fair Value. If a company’s stock trades at $100 and our analysts believe it is worth $200, the price to fair value ratio would be 0.5. A Price to Fair Value over 1 suggests the share is overvalued.

Moat Rating: An economic moat is a structural feature that allows a firm to sustain excess profits over a long period. Companies with a narrow moat are those we believe are more likely than not to sustain excess returns for at least a decade. For wide-moat companies, we have high confidence that excess returns will persist for 10 years and are likely to persist at least 20 years. To learn about finding different sources of moat, read this article by Mark LaMonica.

Uncertainty Rating: Morningstar’s Uncertainty Rating is designed to capture the range of potential outcomes for a company. An investor can think of this as the underlying risk of the business. For higher risk businesses with wider ranges of potential outcomes an investor should consider a larger margin of safety or difference between the estimate of what a share is worth and how much an investor pays. This rating is used to assign the margin of safety required before investing, which in turn explicitly drives our stock star rating system. The Uncertainty Rating is aimed at identifying the confidence we should have in assigning a fair value estimate for a stock. Read more about business risk and margin of safety here.