Value Investing In Companies With Low Levels of Debt
Okay so I know other users have talked about the best investment principles for successful value investing. Things like looking for cash rich companies, ensuring a margin of safety, and so on.
Yet what I would like to cover is why you should make sure you only invest your money in companies with low level of debt. And while it’s true, you’re unlikely to find any well-established business that doesn’t carry some level of financial liability…
You can certainly find companies that rank better on this metric than others. Companies with far lower debt and liabilities.
While a little debt can be a good thing when it helps to provide the funding for business growth and expansion. Since this type of activity tends to raise the overall value of a company.
That doesn’t make it acceptable to invest in a business that’s carrying a large debt load since, it’s very easy for a company to get into trouble once it overextends itself financially and is no longer able to service or repay its loans.
That is to say having too much debt can lead to many financial troubles.
So as a value investor you should be careful when picking a company to invest in when looking at a company’s financial statement you’ll find that there are two types of debt short term debts and long term debts
for evaluating a company’s short term debts.
You can use liquidity ratios and for evaluating the long term debts you can use solvency ratios to find out if a company’s debt level is high or low.
You can compare its debt ratios with that of its rivals and the industry average.
And finally you should also evaluate the company’s ability to repay its short term and long term debts if it can generate enough cash flow to pay its bills on time.
There may not be any problem however if the company fails to pay its bills on time.
It’s going to have a problematic relationship with its suppliers and lenders and that will affect the business in the long run.
Remember that when you buy shares in any company you are effectively lending that company your own hard earned money.
So make sure that you’ll only seek out businesses with low debt loads and a reliable track record for repaying their debts.