Each decade seems to provide its share of investing lessons.

In the 1990s investors put most of their emphasis and time into assessing a company’s profit and loss statement. To be sure, the 1990s was the decade when top-line growth was in the spot­light, and companies were laser focused on grabbing their proverbial mile of the Internet highway. Investors learned that business models mattered, and that hyper growth could never replace long-term profitability.

While revenue growth is certainly an key financial consideration, a company’s balance sheet is just as, if not more, important in determining a company’s ability to provide returns to shareholders over time, especially during such challenging periods as the ’00s, which turned out to be the decade of the balance sheet.

A company’s balance-sheet strength, or lack thereof, often determines the company’s ability to survive and possibly thrive dur­ing inevitable industry-specific or macroeconomic downturns—those 25-year floods that happen every three to five years.

First some basic education: The balance sheet summarizes a company’s assets, liabilities, and shareholders’ equity. Basic balance-sheet considerations include the cur­rent ratio, which is the current assets divided by current liabilities. While acceptable current ratios vary industry by industry, you should generally seek companies with ratios in the 1.5 to 2.0 range. Too low a ratio means that the company may have challenges meeting its short-term obligations, whereas a ratio which is too high may mean the company is not using its current assets efficiently.

The working capital ratio looks at current assets minus current liabilities. This figure will help you determine whether a company is able to meet its near-term obligations. A higher number is preferable, which makes intuitive sense. Leverage is a key measure of a company’s capital struc­ture. Does a company rely solely on its own equity to finance its assets (in other words, is it debt free?), or does it also employ debt? If the latter, how much debt is on the company’s books? By dividing long-term debt by the company’s total equity, you can determine a basic level of leverage. While some amount of leverage can help to improve a company’s return on equity (assuming the capital is deployed in a way that the return on the capital exceeds the cost of the capital), a company with too much leverage puts itself at risk of not being able to meet its obligations if its operations suffer an unexpected disruption (no different than how an over-levered individual will have trouble meeting mortgage obligations if he loses his primary source of income, his job).

There are countless examples of companies surviving to live another day due to their stellar balance sheet. Look at the case of Merck. In brief, this company was a disaster in the mid-2000s. Key drugs came under fire from regulatory authorities, a myriad of lawsuits were filed by patients, and the government sued the company over tax issues. Moreover, the pharmaceuticals industry was in a funk due to the dearth of new blockbuster drugs and the competition from generics. Given this, you would think Merck might be on its way out à la a bad automotive or airline company. Yet, a short two years later the company’s stock was higher and the company’s dividend intact.

Why?

Examining Merck in the mid-’00s as it struggled with legal and op­erational issues, if Merck had a weak balance sheet—if it were highly leveraged with little to no cash on its books—it probably would have been “game over” for the business, or at a minimum, the stock price would have collapsed. Such was the case for many overleveraged companies that went from the heavens to the dustbin in the late ’00s. Yet several years after the company took the biggest body shot it had ever experienced, Merck was going strong, its stock having rebounded nicely and a solid dividend being paid quarter after quarter. Compare this example with the dividend cut made by automaker General Motors Corporation (GM) and subsequent bankruptcy filing during the same time period. Why did this company feel compelled to cut their dividend, something that companies loathe to do? And why could it not recover from its predicament? The answer is due to a weak balance sheet.

This is an important lesson when it comes to equity analysis and financial appraisal. When in doubt, invest in companies with rock-solid balance sheets; look for the industry leaders, the best-of-breed companies that will not be the ones to fail when the inevitable business and financial challenges arise. This focus on qual­ity companies with solid balance sheets will, in and of itself, be a large source of risk reduction when it comes to portfolio construction.

While you do not have to read every footnote of the quarterly 10-Q, by focusing on both the balance sheet and the profit and loss statement, you will increase the likelihood that the other important financial consideration, cash flow, stays positive for your bank account.