Stocks which have zero debt/equity ratio include names like Jubilant FoodWorks which gained 59 percent, and Bata India rallied 50 percent so far in the year 2017.
The word ‘leverage’ as a term has become more of a worry for investors especially after the recent crackdown of the Reserve Bank of India (RBI) on companies with excessive debt on the books.
In the month of June, RBI identified 12 accounts accounting for 25 percent of gross bad loans in the system for immediate bankruptcy proceedings. And, earlier this week, media reports suggest that the central bank is coming out with another list.
The Reserve Bank of India has sent the second list of over 40 large corporate defaulters that include Videocon, JP Associates, IVRCL and Visa Steel, among others, to be referred to the National Company Law Tribunal (NCLT), CNBC-TV18 reported earlier this week quoting sources.
The term ‘debt’ is not essentially bad because to run operations companies do require money to invest into assets, working capital, buy new machinery etc. which would help in improving margins, increase productivity and boost profit.
“Having high debt on the books is not a negative as long as the cash generation out of the usage of the borrowed funds is sufficient enough to service the debt and leave something for the equity shareholders (to compensate them for the risk),” Deepak Jasani, Head – retail research, HDFC Securities told Moneycontrol.
“Typically debt borrowed for investment in commodity sectors at boom times (no distinctive product) or in a Govt subsidised (subsidy on capex/tax or on interest) sector has a chance of creating servicing issues for the borrower (and NPA issues for the lender),” he said.
The S&P BSE Sensex rose by about 20 percent so far in the year 2017 and plenty of small and midcap stocks have more than doubled in the same period.
Among the S&P BSE 500 stocks, we have taken 15 stocks with zero debt across various sectors which have given up to 60 percent return so far in the year 2017. 12 out of 15 companies outperformed Nifty in the same period.
Other stocks which rose between 20-40 percent include names like Colgate Palmolive which rose 22 percent, followed by Greaves Cotton rose 22.2 percent, and Whirlpool India gained 31 percent in the same period.
“Debt is an important component for companies to expand its business beyond geographic reach which finances the capital expenditure. It provides an opportunity for companies to increase its productivity as well as revenue share through its boom,” Dinesh Rohira, Founder & CEO, 5nance.com told Moneycontrol.
“But, with increasing loan defaulter at realm coupled with broadening size of NPA in the economy, the financial health is currently at the edge of eruption. Further, a recent crackdown by RBI on companies with huge debt obligation has escalated concerns for investors to realign its portfolio,” he said.
Things to know when you invest in a Zero debt company:
Ideally, a part of your portfolio should be invested in zero debt or companies which are low on leverage because they might withstand any crisis. They may not turn out to be great when you compare the performance with companies which have slight leverage on their books.
Hence, a part of your portfolio should be in zero debt companies while the rest should be in growth stocks. The strategy will act as a hedge against volatility.
“Low debt or debt free company is not always a good option for investment as there are certain factors which are on backend such as sector growth, economic growth, and credibility of the promoters,” Ritesh Ashar – Chief Strategy Officer, KIFS Trade Capital told Moneycontrol.
“Using conservative approach on interest expense the company may be sacrificing the growth prospects & this can be a disadvantage to its competitors which tap the growth opportunity in the sector by pumping debt,” he said.
Other parameters to track apart from D/E ratio:
There are various other parameters which investors should track before putting money in companies apart from just looking at the debt and equity ratio.
“Investor should scrutinize that every borrowing is aimed at improving fundamental rather than meeting an old obligation. Few financial leverage ratios such as debt-to-equity, interest rate coverage and debt service coverage should be compared with an industry standard to arrive at a logical conclusion,” said Rohira of 5nance.com.
Ashar of KIFS Trade Capital said that investors’ attention to a level is acceptable which can be seen through Interest Coverage Ratio, Debt Equity ratio & ROCE vs Interest rate charges.“Leveraged companies face issues of cash crunch and repayment of loans whereas zero debt companies are free from these hassles. As the interest rate increases the lending becomes expensive and dilutes profitability,” he said.The Great Diwali Discount!
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