Debt is a very important factor while considering to buy a stock.A company might be selling at a price lower than its book value and may also have a low P/E. It may also be growing at a decent rate. But what if the company owns a lot of debt and during one year of loss, it ends up selling a lot of its assets to pay the interest.
Whenever anyone takes a loan, he needs to return not only the principal but also pay an interest of around 10-15 percent.So while buying a stock, look at the balance sheet and see the loans a company has, compare it with the networth it has and also the interest it is paying annually.
So where can you find all this information. When you look at the balance sheet of a stock, there are few terms you got to put more stress on.
Networth(Stockholders' Equity) = the value of assets the shareholders hold, which includes the equity capital which was the money when it was raised and reserves , which is the money that is subsequently added to the kitty.
Stockholders' Equity divided by total number of shares= Book value of the share (from our previous article)
Liabilities= this includes secured and unsecured loans
Liabilities and Stockholder' equity= Assets
Liabilities and stockholders' equity is equal to the assets( land, machinery and inventory ) the company holds.
The interest the company pays annually can be seen in the profit and loan section.
Now suppose the company has a networth or equity of 100 crore and debt of 1000 crore. So its total liability and equity is 1100 crore. Its assets also should be 1100 crore. Now, suppose the company is making a profit of 200 crore every year. To pay the interest on debt. the company pays 100 crore(assuming the interest to be around 10 percent). Now one year the company does not make a profit. To pay that years' interest of 100 crore, their entire equity will be used up and all the money of shareholders' would be gone. Though the company would not do that and take some money as loan and wait for the next year to stabilize and return to profitability. But this is what i am talking about. Interest on debt grows without rain.
At the same time, if a company does not take any loan , it is letting go the opportunity it could have had by using that money to make more profits. so what is the ideal debt.
RULE 4: A company's debt should be less than half of its networth or equity.
The annual interest it pays should be less than quarter of its PBIDT(profit before Interest, Debt and Tax)
Now time for the pick of the week: Tara Jewels. It is trading at Rs 77.50 at NSE presently.
It is a decent stock which has a debt around half of its networth. it is trading at less than half of its book value. It has a P/E of around 4. Some sites may show a P/E of 6, but i am using the consolidated results for computing P/E as they are more reliable. The difference between standalone and consolidated results will be discussed in next article.
For any queries about investing in equity, just post us in a comment and we will solve your doubts in 24 hours.
Whenever anyone takes a loan, he needs to return not only the principal but also pay an interest of around 10-15 percent.So while buying a stock, look at the balance sheet and see the loans a company has, compare it with the networth it has and also the interest it is paying annually.
So where can you find all this information. When you look at the balance sheet of a stock, there are few terms you got to put more stress on.
Networth(Stockholders' Equity) = the value of assets the shareholders hold, which includes the equity capital which was the money when it was raised and reserves , which is the money that is subsequently added to the kitty.
Stockholders' Equity divided by total number of shares= Book value of the share (from our previous article)
Liabilities= this includes secured and unsecured loans
Liabilities and Stockholder' equity= Assets
Liabilities and stockholders' equity is equal to the assets( land, machinery and inventory ) the company holds.
The interest the company pays annually can be seen in the profit and loan section.
Now suppose the company has a networth or equity of 100 crore and debt of 1000 crore. So its total liability and equity is 1100 crore. Its assets also should be 1100 crore. Now, suppose the company is making a profit of 200 crore every year. To pay the interest on debt. the company pays 100 crore(assuming the interest to be around 10 percent). Now one year the company does not make a profit. To pay that years' interest of 100 crore, their entire equity will be used up and all the money of shareholders' would be gone. Though the company would not do that and take some money as loan and wait for the next year to stabilize and return to profitability. But this is what i am talking about. Interest on debt grows without rain.
At the same time, if a company does not take any loan , it is letting go the opportunity it could have had by using that money to make more profits. so what is the ideal debt.
RULE 4: A company's debt should be less than half of its networth or equity.
The annual interest it pays should be less than quarter of its PBIDT(profit before Interest, Debt and Tax)
Now time for the pick of the week: Tara Jewels. It is trading at Rs 77.50 at NSE presently.
It is a decent stock which has a debt around half of its networth. it is trading at less than half of its book value. It has a P/E of around 4. Some sites may show a P/E of 6, but i am using the consolidated results for computing P/E as they are more reliable. The difference between standalone and consolidated results will be discussed in next article.
For any queries about investing in equity, just post us in a comment and we will solve your doubts in 24 hours.
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