NiftyLiveCharts Blog

we helps you to understand the Stock Market

Avoid Investing In Companies With Excessive Debts

by

Why You Should Avoid Investing In Companies That Have Excessive Debts
It’s not abnormal for companies listed on the stock market to have sizeable debts. After all they usually need to borrow money to expand their business. However from an investment point of view, you have to be very careful about investing in companies that have excessive debts.
This is particularly the case at the moment because the worldwide credit crunch has really limited a company’s financing options. Credit is now a lot harder to come by so it’s now a lot harder for smaller companies to get their hands on the capital they need to expand their business.
There is also the fact that the current worldwide recession has resulted in falling demand for products in almost every sector of the economy. What this means is that those companies with already high levels of debt are going to struggle to pay off this debt if their revenues and overall profits are greatly reduced. In the long term this can have a catastrophic effect because if the overall level of debt keeps going up at a faster rate than profits, then the end result is usually bankruptcy.
So this is something you have to bear in mind when looking for potential companies to invest in. You really must look at the financial accounts in order to see how much debt a company has.
Nearly all companies have some level of debt because it’s a major cost of running a business but the important point is that if a company is going to grow, or survive even, then this debt must be easily serviceable in the long run. To find out this information you should look at the net debt and net profit figures for both the current year and previous years (and look at future projections as well).
A solid company will ideally have net debt that is no more than around three times net profit. If it’s substantially more than this and the company isn’t projected to grow it’s profits very much in future years, then they could face financial difficulties in the future.
So the point is that whenever you are looking for potential investment opportunities, you should always take the levels of debt into consideration, particularly at the current time when demand is falling and credit is harder to come by. If you just look at things like revenue, profit projections and future PE ratios, but disregard debt completely, then you could be in for a nasty surprise because the company may have large debts which are not adequately covered by their profits.

Nearly all companies have some level of debt because it’s a major cost of running a business but the important point is that if a company is going to grow, or survive even, then this debt must be easily serviceable in the long run. To find out this information you should look at the net debt and net profit figures for both the current year and previous years (and look at future projections as well).It’s not abnormal for companies listed on the stock market to have sizeable debts. After all they usually need to borrow money to expand their business. However from an investment point of view, you have to be very careful about investing in companies that have excessive debts.

This is particularly the case at the moment because the worldwide credit crunch has really limited a company’s financing options. Credit is now a lot harder to come by so it’s now a lot harder for smaller companies to get their hands on the capital they need to expand their business.

There is also the fact that the current worldwide recession has resulted in falling demand for products in almost every sector of the economy. What this means is that those companies with already high levels of debt are going to struggle to pay off this debt if their revenues and overall profits are greatly reduced. In the long term this can have a catastrophic effect because if the overall level of debt keeps going up at a faster rate than profits, then the end result is usually bankruptcy.

So this is something you have to bear in mind when looking for potential companies to invest in. You really must look at the financial accounts in order to see how much debt a company has.

A solid company will ideally have net debt that is no more than around three times net profit. If it’s substantially more than this and the company isn’t projected to grow it’s profits very much in future years, then they could face financial difficulties in the future.

So the point is that whenever you are looking for potential investment opportunities, you should always take the levels of debt into consideration, particularly at the current time when demand is falling and credit is harder to come by. If you just look at things like revenue, profit projections and future PE ratios, but disregard debt completely, then you could be in for a nasty surprise because the company may have large debts which are not adequately covered by their profits.