When you examine corporate growth, the usual measurements — sales and profit — come from the income statement. But you can also measure growth from the balance sheet, by comparing how key items change.

Balance sheet changes produce answers that help evaluate corporate strength. For example, a company that over a period of years cuts long-term debt while building its capital (shareholders’ equity or book value) is surely becoming stronger and cutting risk.

And a growing company that plows reinvested profit into book value at a faster rate than it increases long-term borrowing is probably doing something right.

A company whose shareholders’ equity has eroded and whose debt has increased must be suspect in quality and safety, no matter how bright its sales and earnings prospects may seem.

This comparison sidesteps the issue of capital structure, the appropriate ratio of equity to debt for a company or industry. But increasing debt more than equity increases financial leverage, with the resulting risk of greater volatility in earnings. Cutting debt relative to equity cuts leverage, and therefore cuts potential earnings volatility.

The accompanying table shows highlights from examining the books of 70 Canadian large-cap and mid-cap companies (including seven banks). The 37 names come from the S&P/TSX large-cap and mid-cap indices. The period covers from the end of 2001 to the end of 2004.

To be sure, the list is loaded with energy companies and financial institutions. But they, after all, account for the largest portion of the Canadian stock markets.

An additional feature of the table is a measurement of change of cash in the balance sheet.

The significance of this item varies; cash is generally a small amount in any balance sheet. Banks’ stock-in-trade is money, so changes in their cash holdings may not be all that significant. Some companies can operate without any or little cash in the till, so a change in their cash situation is not material. And, as a company grows, its need for holding cash may become relatively less important.

Still, it is nice to know that a company you are interested in has increased its cash at hand. It reinforces the picture of a strengthening balance sheet, the underpinning of investment quality.

The centrepiece of the 70 companies and banks examined is the list of 18 firms that grew their equity, cut their debt and added to cash between the 2001 fiscal yearend and the 2004 fiscal yearend.

There should be little surprise that most of the 18 have been performance stars in the market, although some are late bloomers — Métro Inc., for instance.

The 14 companies whose equity and debt both increased, but whose equity grew faster than debt, are also mainly performance stars.

In general, a fast-growing company should be able to finance most (if not all) of its expansion from profits. But sometimes growth opportunities are so great that borrowing becomes part of the corporate strategy. You see this particularly in energy companies.

This comparison avoids discussion of sales and earnings. Book value growth results from net income growth, and earnings growth over time reflects sales growth.

These elements are closely linked. As George Lasry, an investment manager in New York, pointed out years ago: “Essentially the same accounting used to calculate book
value is also used to calculate income.”

A company whose accounting is liberal in producing earnings also increases its book value, and this raises the bar for management to maintain profitability (return on equity). IE