Thinking about religion has been a taboo for some time. “Religion: The First 5,000 Years” by David Graeber bears this quote: So, the criminalization of debt was the criminalization of the basis of human society.
Many investors believe that this is the best way to earn high investment returns. But in reality, zero-debt firms, although they tend to book a higher profit margin, are also likely to have a higher financing cost.
Having a higher level of debt on the books does not make companies worthless investments as long as the borrowed capital is used towards additional capital expenditures or entry into new product sectors because these can boast a high growth trajectory. For example, L&T and Thermax have high loans, but both boast solid fundamentals to beat the slowdown.
Anything that leads to growth and expansion from a small amount of debt can actually be to the advantage of the company. However, having a negative cash flow situation is not good but having a small level of debt can be beneficial for the company.
Debt can also extend the return on equity for equity investors. By borrowing, the company increases its assets, thanks to the cash that comes in. But since equity is equal to assets minus total debt, the company reduces equity by increasing debt and when the return on investment (ROI) on capital is higher than the cost of borrowing, this leverage works to the benefit of equity shareholders and ROI expands .
In other words, when debt increases, equity decreases, and since equity is the denominator of return on equity, return on equity, in turn, gets a boost.
The extra interest in debt also helps companies save on taxes.
Good debt is a representation of an investment made by the company for the future of the company, that is, the debt does not have an overall negative impact on the financial position of the company, and it can be repaid.
Recently, Reliance announced the raising of $4 billion via 40-year forex bonds at an astonishingly low rate of 2.8% to 3.75%. They also have big plans in three future growth areas – green hydrogen giant factories (around INR 75,000 kroner), 5G spectrum bidding, and multi-channel retail.
They plan to use the proceeds to pay off existing debt, including a $1.5 billion loan maturing in February.
Increasing this bond will help the company to reduce the interest cost as the new loan will have a lower interest rate than the old loan and increase profitability. This cost is well below the MCLR banking rate which is currently 7%+ for Indian banks.
Does it make more sense for investors to stick with zero or low debt stocks? Is it good to be debt free? Or is religion a good idea?
- religion is good
- No to debt.