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What do you mean when you say to avoid debt-laden securities?

Your longer version of this question, which I have summarised above, seemed to be looking for some decision rules in terms of absolute and universal numbers. I am sorry, but this is not the way to address this issue.

Debt is a marker of financial risk. Financial risk is basically the ability of the company to meet debt service payments and debt repayments on time, even in difficult times. If a business is in a cyclical industry (one whose revenue and profits rises and falls with the level of economic activity), then it has more financial risk with a given debt to equity ratio than a company in a non-cyclical industry.

The other aspect is that if a company finds itself in trouble for a while, a high debt to equity ratio is a marker of more risk than a low debt to equity ratio. If debt is low, there is borrowing capacity unused in a difficult time, but if the debt level is already high, there is no fall-back borrowing capacity.

So, the first step is to look at the debt to equity ratio. The lower it is the better in financial risk terms. Certainly it is also a safety valve in hard times. Then you have to assess it against its competitors as discussed above.

It should also be noted that I said securities, not shares in my talk. There are quite a range of securities you can buy these days. A trust and a company are different beasts. You need to know that and what the implications are. Also, there are stapled securities, which are a trust unit plus a share. This is a different animal again. I personally avoid these securities and confine myself mainly to companies, because they have more growth potential from retained earnings. Trusts can not retain earnings because of the way the tax law works. There are many more wrinkles to these securities, about which I am not an expert, so I cannot comment in detail. I follow Warren Buffett’s dictum of not investing in businesses that I do not totally understand.

 

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