Get out of debt now! (in your portfolio)
The stocks of companies with low debt loads have far outperformed shares of firms leveraged to their eyeballs this year. That trend is likely to continue.
NEW YORK (CNNMoney.com) -- If this recession has taught us anything, it's that debt can kill.
Consumers seem to have figured this out. They are starting to cut their debt loads and save more.
But there's also a lesson here for investors and Corporate America. Firms that are heavily in hock should be avoided. In fact, shares of companies with higher-than-average debt levels have underperformed their less-levered peers by a wide margin.
According to figures from Thomson Baseline, shares of S&P 500 companies with a long-term debt to capital ratio below 34% -- the S&P 500 average -- are up an average of 10.3% this year. The S&P 500 stocks with debt loads above 34% are up only 1.2%.
This holds true for smaller companies too. Firms in the S&P SmallCap 600 with a below-average debt load are up 7.2% this year while those with higher debt loads are down 1.6%.
And if investors really want to maximize their returns, they might be better off investing in companies with no debt at all.
Shares of S&P 500 firms that are debt-free are up an average of 15.6% this year. Debt-free tech giants Apple (AAPL, Fortune 500) and Google (GOOG, Fortune 500) have both surged more than 30%.
Mark Travis, president of Intrepid Capital Funds, a Jacksonville Beach, Fla.-based money management firm, said that a strategy of sticking with conservative companies that have strong balance sheets is definitely worthwhile in an environment such as this.
His firm's Intrepid Capital fund is up 10.5% this year while its Intrepid Small Cap fund is up 12.5% year-to-date.
Travis said some of the top picks in those funds are companies that may not seem overly exciting, such as Harry Potter publisher Scholastic (SCHL), telecom equipment firm Tellabs (TLAB) and Tidewater (TDW), a marine vessel contractor for the oil industry. But they all have pristine balance sheets and their stocks are up this year.
"When it comes to stocks, we are anti-leverage and that looks sexy now. There is the famous quote from Warren Buffett about when the tide rolls out, it's easy to see who's swimming naked," Travis said.
Talkback: How worried are you about the debt loads of consumers, businesses and the government? Are you taking steps to cut your debt? Leave your comments at the bottom of this story.
Sure, raising money through the sale of corporate bonds could be necessary to help finance expansion. And as long as companies are responsible with how they handle their balance sheets, debt doesn't have to be a four-letter word.
"In times like this, companies with high cash and low debt levels are in a better position to survive and take advantage of opportunities to grow through acquisitions," said Craig Callahan, founder of ICON Advisers, a Greenwood Village, Colo.-based investment firm with $3.5 billion in assets under management.
Still, companies that rely on debt could be in for a rude awakening given that the credit markets remain shut fairly tight, despite the Federal Reserve's repeated attempts to pry the window open by keeping interest rates near zero.
"The Fed has its foot pushed to the floor in a Porsche 911 S," Travis quipped. "But it took a while to get into this credit crisis and it will take a while to get out."
And investors may not be forgiving of companies that go on debt binges -- even though money is cheap.
"Many companies in 2005, 2006, and 2007 looked at how low rates were and borrowed money to buy back shares so they could boost earnings per share. It looks like the recession has put an end to that," Callahan said. "Investors in general have changed their risk tolerance during the past two years."
Plus, now that the rating agencies are on a crusade to show that they have teeth, even solid companies risk downgrades if they lever up too aggressively.
"Any type of financing is tough to come by. And in cyclical businesses, firms with no or little debt have a competitive advantage," Travis said.
So even if the market rally resumes and signs of an economic recovery become more evident, don't get suckered into companies that are piling on debt just because rates are low.
Lehman Brothers, General Motors (GMGMQ) and mall operator General Growth Properties (GGWPQ) -- just to name a few recent big bankruptcies -- should serve as sobering reminders of what happens when debt burdens become an albatross.
Talkback: How worried are you about the debt loads of consumers, businesses and the government? Are you taking steps to cut your debt? 
