India experiences both high inflation and high interest rates. Immediate effect of both on companies finance is negative. High interest rates clearly affect companies operating costs profit margins. Companies which remain isolated from effects of high interest rates are debt free companies.
The companies which are more dependent on debt to manage their working capital, face the burnt of high interest rates. Interest rates of debt is fluctuating. When interest rates goes up, it will eventually increase the expense of company. This will automatically translate in profitability of the company.
Zero debt companies in India are ones which are more self reliant. Such companies are best suited for long term investing.
Profitability of zero debt companies are generally more than high debt companies. Debt is a liability which has also a big cost attached to it. Debt gives immediate relief but its also an expense for the future. Hence companies will lesser profit but zero debt are preferable.
In India we have several zero debt companies.
It will be not be wrong for us to base our investment decision starting from such companies.
High interest rates negatively effects the profitability of high debt companies. In periods of soaring interest rates, low debt and debt free companies emerge as clear winners.
In India, interest rates remain very unpredictable. One never know when rising trend will start again. This mainly happens mainly due to wavering inflation.
In India inflation can stabilizes for few year. But even with minor changes on political front, inflation cuts deep again.
Study of debt levels of companies certainly helps. How dependent is company on debt, over long periods of time, speaks a lot about its fundamentals.
Only single year study will not be enough. Hence it is advisable to keep last 5 years financial reports of companies handy.
In this age of fast internet we can keep soft copies of financial statements. Internet enables access to information related to companies with click of a button.
1) Debt free companies are profitable stocks.
2) High interest rates reduces profitability of debt companies.
3) Zero debt companies have strong business fundamentals.
4) Debt free companies stocks must be preferred for investing.
5) Keeping ready-list of debt free companies is a good.
Even small increase in interest rates can create big hole in companies profits.
A company, whose turnover is Rs 34,000 Crore incurs Rs 1,300 Crore of Interest Expense.
This interest expense is 3.8% of total turnover of company.
In terms of expense requirements, 3.8% expense on any one item is is considers very high.
Even marginal increase in interest expense can effect profitability. To negate high interest costs, companies avoid maintaining high debts.
In case debt levels cannot be reduced, companies profits reduces. This is one compromise high debt companies makes all the time.
Debt free companies are completely free of such compromises.
Companies which are debt free generates their liquid cash comparatively easily. This cash is used to manage current liabilities.
When there is no debt (immediate interest expense), companies liquidity level remains good. This makes day-to-day cash cash flow management relatively simpler.
Debt free companies are low risk companies for investors. Not only investors but even bankers love such companies. When need comes and such companies need debt, banks can lend them debt at low interest rates.
Such companies has enough cash generating source of their own. They do not need market debt to run their business.
This situation may sound simple, but it take decades for companies to reach this stage.
It has also been observed that, generally debt free companies share higher dividends with its shareholders.
If company is focusing on long term growth, they may not distribute high dividends. But big, debt free companies share reasonably high dividends and also manage fast growth.
In order to understand this correlation, lets take an example. Look into NMDC’s balance sheet. In last 10 years NMDC had zero debt. During the same period, company was able to increase its reserves at staggering rate of 28% per annum.
Zero debt and fast increasing reserves is an excellent indicator of strong business fundamentals.
NMDC s is good example of debt free company. Looking at companies Profit loss accounts, NMDC’s Total Income has increased at rate of 19% per annum. While NMDC’s Total expense has increased at rate of only 15% per annum. This differential between income and expense enhances companies profit and profitability. NMDC s profit and profitability both has improved in last 10 years.
Generally debt free companies are good bet for investment. But all debt free companies may not be good.
A scrutiny of business fundamentals is a must before one goes ahead and buy their stocks.
Its will be good idea to check companies Total Income growth (sales turnover) . Though company is maintaining zero debt but; if it is not able to increase turnover, it will not be considered good.
To get more idea, compare sales turnover of company with its nearest competitors.
Concept says, it’s a good practice to keep debt levels as low as possible. But this should not be done at cost of business growth .
Companies which are compromising its growth are either complacent or does not have skillful dynamic top managers.
A combination of high sales growth and low debt is ideal. Investors must keep track of such companies. Also, companies maintaining high profit margins automatically becomes most preferred by investors.