Two major problems that companies today encounter are high rates of interest and inflation. Since these two factors dent corporate earnings considerably, it is very important for investors to select companies that are debt free and also have funds for expansion.
Since these companies are debt free, they don’t incur interest expenses and therefore generate higher profits than those that have debt to service. If one is able to identify such companies, buy their shares at the right price and hold on to them, it will generate decent gains over the long run.
There are some companies that have an interest outgo which is an average five per cent of their revenues. Even a small hike in interest rate will have a huge impact on the earnings of these companies. During bad times, such companies are even forced to pledge their shares to borrow more and this can push them deeper into debt.
This is where cash rich companies stand out. They have enough cash in hand that is available to meet any kind of expenses that the company may incur. Since they do not have to borrow, they save a lot on the interest expenses. And this, in turn boosts their net profits. This incremental profit goes into the reserves and in turn strengthens the company’s balance sheet. Such companies are also able to pay a higher rate of dividend and investors stand to gain more by investing in such companies.
One should look for shares that are trading below their book value. Since these companies offer more than five per cent in dividend yields, they offer a great investment opportunity.
The probability of making a loss on investment in shares of debt free companies is very low. Even if such a company has to borrow money, it can get loans at a lower rate than its peers owing to its higher credit ratings.
Good management is the driving force behind all good debt free companies. The management should be stable and long lasting for these companies to prosper. Usually, such companies will have a very good record of operations and that itself reduces the risk on investments in its shares, while increasing profit potential.
For example, let us talk about National Mineral Development Corporation or NMDC. The company is debt free and its reserves have gone up by 28 per cent over the last 10 years. Yearly net profit growth has been around 19 per cent while expenses remain at only 15 per cent. All these factors indicate the profit potential of NMDC. The company has been showing good performance over the last ten years.
Being debt free should not be the only criteria
All debt free companies are not worthy of your investment. One should also look at the yearly sales growth of the company. Apart from this, one should also check the history of the company in terms of shareholder value creation. Investing in shares of companies that have issued bonus shares, have paid decent dividends in the past or made rights issues can ensure a healthy return on one’s investment.
(In arrangements with Sampadhyam)