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How to Find the Best Low Debt Companies ft. Harsh Vora - YouTube
Channel: Tickertape
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hi and welcome to ticker tape this is
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harsh bhura and in this video we will be
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screening top debt free or low debt
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companies out of a universe of more than
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four thousand companies and we'll also
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briefly discuss three of them now before
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we start let me ask you
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is debt always bad
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well the answer is it may depend on a
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host of factors one of which is the life
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cycle of a company now imagine startups
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for instance right these are companies
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that may struggle to generate sales they
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may hardly have enough profit and may
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even have negative free cash flows you
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see they may even struggle to break even
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on their initial investment or be able
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to cover their expenses three to four
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years down the line and so given this
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situation do you think any bank or a
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financial institution would be
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comfortable in lending out their funds
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to such companies well the answer is
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obviously not right and so these
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startups tend to bring their own funds
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the owner's own funds are what we call
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equity into the business and then three
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to four years down the line when these
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startups get stable when their business
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model is proven and when they start
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generating sales and cash flows then
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they can afford to pay interest on their
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loans and it is at this time that they
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can afford to approach a bank or a
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financial institution and say hey now my
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business is stable i have a proven
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business model my products are being
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sold and i wish to grow i wish to reach
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more customers i wish to expand and so i
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wish to seek loan from you at this stage
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the bank will find it profitable to lend
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their money to these companies so these
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are called growth stage companies one
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are startups and then they can mature to
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grow stage companies and that may help
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these growth stage companies in two ways
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one
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that helps them get access to funds that
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may in turn help them hire more talent
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for instance hire more employees or it
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may also help them spend on marketing
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their products or services to help reach
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more customers right now you may ask why
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borrow to grow why not use your own
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funds why not why not bring more
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investors into the business right well
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the answer is obviously that is an
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option but that may also lead to
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dilution of the stakes of existing
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investors so those of you who have what
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shark tanks would relate to this if a
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founder owns 100 of a business by let's
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say bringing 10 lakh rupees initially
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and if he wishes to bring another
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investor to invest an additional rupees
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10 lakhs into the business then the
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stake of the founder the original
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investor would reduce to 50 right and if
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they both wish to bring a third investor
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to invest in additional rupees 10 lakhs
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then the stake of each investor would
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reduce to 33.33
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right
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so my point is debt does not imply
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ownership a lender is only entitled to a
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fixed rate of interest plus principal at
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the time of maturity but is not entitled
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to a stake in the company like the
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owners right in other words borrowing is
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a source of external financing
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the second way that debt can help grow
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stage companies is through helping them
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reduce their cost of capital now what is
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cost of capital you see fundamentally
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there are three forms of capital one is
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financial capital which may include debt
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loans taken from banks or financial
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institutions or equity or owner's own
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funds right this forms financial capital
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second is human capital or the talent
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that the company retails the talent that
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the company hires right and this is one
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of the most important form of capital
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third that is physical capital or land
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or buildings that the company uses to
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manufacture or provide the services to
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their customers right so these are three
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forms of capital just like any good
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thing in life comes at a cost there is a
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cost attached to all these three forms
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of capital so for instance if we are
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talking about human capital then the the
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cost of that capital the cost of labor
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is the salary and wages that the company
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has to pay to the employees the cost of
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land is the rent that the company has to
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pay or the cost that the company has to
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pay to acquire that piece of land or a
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building then the cost of what is the
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cost of financial capital
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the cost of debt for instance is the
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interest expense that the company has to
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pay on the loans that it takes from the
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banks or financial institutions right
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and the cost of equity the cost of
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owners own funds is the dividend that
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the company has to pay to those owners
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you see the owner could have invested
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those funds in some other business that
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could have given more profit to him
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right the owner could have simply
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invested in mutual funds function why
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start new business
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so there's an opportunity cost attached
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to the owner's own funds as well and
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that is also a cost of capital so now
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that we understand what cost of capital
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means let's also try to understand how
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debt helps reduce that cost of capital
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right in finance we have something
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called the hierarchy of claims and what
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this means in simple terms is in the
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event that a company happens to undergo
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bankruptcy the court will order all the
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assets of the business to be sold off
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right so assets including land building
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machinery and everything to be sold off
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and again this is a very simplified
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explanation the actual process of
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bankruptcy is very lengthy and complex
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but again we are simplifying matters
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here so what happens is in the event of
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bankruptcy the code orders these assets
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of the business to be sold off and
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whatever proceeds cash flows are
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received from selling of those assets
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building land machinery and so forth
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would be distributed according to the
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hierarchy of claims and in the hierarchy
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of claims the owners have the first
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claim on the proceeds on the cash flows
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that are received after selling
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buildings and land and machinery and so
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forth the lawyers fees have to be paid
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first and then the lenders must be paid
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their loans along with interest if there
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are any cash flows left and once the
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lenders are paid then the owners of the
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business will paid any remaining cash
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flows that are left from selling of the
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assets in other words the owners have
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the last claim on the cash flows of the
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company and because they have the last
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claim on the cash flows they also are
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entitled to a higher return because they
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need to be compensated for the risk they
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are taking so dividends which are paid
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to the owners are normally higher than
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the interest rate that the lenders are
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entitled to because loans are relatively
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more safe
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than the owners own funds they have a
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higher claim on the assets of the
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company in the event of bankruptcy
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their money is relatively safer compared
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to owner's own funds and because
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they are low risk they also come with
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lower return and the interest rate is
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lower so if the owner's own funds the
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equity the cost of equity is 13 to 14
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then the cost of debt or the interest
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rate would be around six to eight
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percent so
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because the cost of debt the interest
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rate is lower than the cost of equity
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the overall cost of capital for the
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company would on average reduce so what
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i'll normally look at is how much the
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company how much debt the company has
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compared to the owner's own funds or
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equities so i look at debt to equity
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ratio and normally i look at companies
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that have debt to equity ratio of less
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than 40 percent and then obviously
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second thing that i look at is interest
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coverage ratio what is interest coverage
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ratio it tells us how much interest the
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company is able to pay out of its
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profits so let's say if the profits are
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100 crores but the interest payment is
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around 10 crores every year then that
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means the company will be able to pay 10
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times the interest it is paying now out
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of its profits so the company's profits
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are 10 times larger than the interest is
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paying which is which means that the
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interest payments are more or less
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comfortable so interest coverage ratio
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is second thing that i look at and the
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third thing that i look at in low debt
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companies or companies that have that is
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return on capital employed now return on
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capital employed is how much profit the
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company is generating out of its total
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invested capital now what we want as
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investors is for the return on capital
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employed to be greater than the cost of
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capital so if the return if the profits
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that the company gets from the cost of
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capital that is employed in the business
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is larger than the cost of capital the
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interest payments that the company is
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making to debt or the dividend that the
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company is paying to the
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shareholders if the profits are greater
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than that then then that means that the
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cost of capital is affordable and the
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company is growing the company is
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profitable so we want return on capital
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employed to be greater than the cost of
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capital generally what happens is most
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companies have a cost of capital between
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10 to 15 even 18 so having a capital
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return on capital employed of more than
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20 is the best and all quality companies
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normally have a return on capital
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upwards of 20 some have even more than
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30 even 50 but obviously these are
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companies that are very expensively
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valued and so it may not always be the
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right time to invest in those
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expensively valued companies a quick
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note here understanding finance can be
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difficult and complicated
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but having experts discuss financial
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topics can help simplify it introducing
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where's my money ticker tapes very own
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podcast that brings expert views on
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important developments in finance so
[554]
tune in to where's my money every week
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to decode financial topics so with that
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in mind we will go ahead and screen top
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debt free or low debt companies out of a
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universe of 4 400 companies on ticker
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date all right so on ticker tape we'll
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go to the screener window and this gives
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us a list of 4400 more than 400
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companies okay so now to narrow down
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our list to those companies that have
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low to negligible debt what we'll use is
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we'll add some filters here so at the
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bottom left if you click on add filter
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and go to financial ratios what i use is
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long term debt to equity because we want
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companies that have long term debt to
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equity of less than 40 in general now
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again this depends on a lot of
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industries and sectors as well right
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we'll also select interest coverage
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ratio now remember what interest
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coverage ratio tells us is how much
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profit do we have compared to the
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interest expense then we also want to go
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to profitability column and select
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return on capital employed because as we
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discussed earlier we want companies that
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have return on capital employed of
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greater than 20 right so we select
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return on capital employed as one filter
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then another filter that i like to add
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is in the growth we want five year
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earnings per share growth so we want
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companies that are growing faster right
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we don't want slow growth companies
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click on done and now what i like to do
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is i like to add this list on excel so i
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like to export it on excel and then
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analyze companies filter screen on
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companies on excel that is easier and
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we'll do that now so that you get an
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idea so we have these things and uh what
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we can do is we can click on export and
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you can title this anything let's say
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ticker tape filter
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one okay now click on export results
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and there you go you have about nine
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columns here what we'll go ahead and do
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first is adjust the column width so that
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we get a proper clearer view right and
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i'll also go ahead and delete ticker
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column and market cap column because
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here we will be looking at all companies
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whether micro cap small cap mid cap or
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large cap and the last thing that we
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need to do is to add filter to all these
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columns this filter this drop down menu
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will allow us to sort these companies as
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per the the level of threshold that we
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want so what you do is you go to you
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select the first row top row and then go
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to
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data and then click on filter
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and it'll add drop down menu
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on all columns
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and there you go so we have so first
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thing that we'll do here is select all
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those companies that have debt of less
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than or equal to let's say 10 okay let's
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uh select very low negligible debt
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companies right so there are about 22 on
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the bottom left hand side of this excel
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you will notice that there are about
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twenty two hundred companies out of a
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list of four thousand four hundred
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companies that have a debt of less than
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ten percent i forgot to do one more
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thing here is to change the decimals to
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one all right so we have one decimal we
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have changed our long term debt to
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equity filter to all those companies
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that have less than 10 percent debt to
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equity and then we'll one more thing
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that will change here is return on
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capital employed we want only those
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companies that are generating return on
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capital of more than 20 see most
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companies have a cost of capital
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anywhere from 10 to 18 right so quality
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companies tend to have lower cost of
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capital because banks are more willing
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to lend these companies and so they have
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a lower cost of capital but by having a
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higher threshold of return on capital
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employed we would have more or less
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assurance that the companies in this
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list are able to not only cover their
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cost of capital but also general return
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higher than the cost of capital for
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their investors so we'll select a return
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on capital employed of greater than or
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equal to 20 so this will narrow down our
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list to 400 a little more than 400
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companies out of 4 400 companies you see
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there are very few companies that are
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generating return on capital of more
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than 20 this is a list of quality
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companies that may not be only available
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at attractive valuation because there is
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a demand for these quality companies and
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so the valuation of the companies are
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through the roof so we have roc of more
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than 20 we have long term debt to equity
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of less than 10 and then one more thing
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that i like to do is five year
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historical earnings per share growth i
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want that greater than 20 so that will
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narrow down our list even further so we
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want companies that are generating
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profit in the last four years every year
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greater than 20 and that reduces our
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list to less than 200. as you can see
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the list of the companies spans from a
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nestle so fmcg to insurance to software
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services pharmaceuticals to specialty
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chemicals to construction and
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engineering which are highly capital
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intensive lots of good quality companies
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that you can see here nestle forage l t
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technology services you'll see the stock
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price of these companies and they'll
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they'll always be rising more or less in
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the past 10 years right obviously this
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tells us nothing about the future but at
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least you have an assurance that the
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financials of these companies are top
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notch right you have astral poly these
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are all consistent compounders abort
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india bala krishna industries which
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manufactures off-highway tires then we
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have alkyl mines icsa securities
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coromandel fertilizer company we have
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gas distribution companies in the
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enterprise gas we have polycab india
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which is again a top quality company
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generating top return on capital
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employed so uh now again this is a list
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of 200 companies and we have obviously
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used a very conservative threshold of 10
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long term debt to equity so it's not
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giving us a whole lot of companies that
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have more debt on their books but there
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are still growing profitably so three
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companies that i particularly like in
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this list i'll show i'll tell you the
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list is one is a crystal right a crystal
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is a quad's kitchen sink manufacturer it
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is the top most company across asia that
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manufactures quartz kitchen sink and
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with the real estate demand uh growing
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recently acrysil has also been expanding
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its capacity to about 10 lakh sinks per
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year now so has good growth prospects
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his financials look good demand stays
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strong obviously you can study more by
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reading their annual reports and
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investor presentations and con calls by
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going to nse website or even on ticker
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tape you will find investor
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presentations and everything but a
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crystal is one company that i'm very
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bullish on personally again this is not
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a stock recommendation or an investing
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advice i recommend that you study
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yourself or or consult a semi-registered
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advisor before taking an investment
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decision but yes so crystal is one
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company that
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you can keep in your radar another
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company that i like in infrastructure
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specifically in construction and
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engineering sector is knr constructions
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uh it is into road construction services
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long-term debt to equity is around 36
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percent not bad for an infrastructure
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company right uh high uh return on
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capital employed interest coverage ratio
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is is four which is more than enough to
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cover their interest compounded earnings
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growth is around 30
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right so yeah we so that is another
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company that i would keep in my radar
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knr construction the first is a crystal
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and then the third company that i like
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is right above that which is prince
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pipes and fittings it is the fifth
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largest pipe manufacturer in india
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obviously one of the top companies is
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astral poly right which is also in this
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list prince pipe is growing at a fast
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rate as well um you can see that it's
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relatively attractively valued at 37
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price to earnings long term debt to
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equity only 10 percent one percent in
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fact not even 10 and uh and then return
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on capital employed of 30 interest
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coverage ratio high earnings per share
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growth is 26 percent so prince pipes is
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one knr construction a crystal obviously
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the fourth company that i'm bullish on
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is polycab but you can go through all
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these companies and then research more
[996]
dig more into these in it sector mastic
[999]
is a really attractive company again so
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go ahead to these companies uh and tell
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me
[1004]
tell me in the comment section which
[1006]
company do you particularly like out of
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this list or just create your own list
[1011]
tell me
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which filters are you using and based on
[1014]
these filters which companies do you
[1016]
prefer in the sector again remember this
[1018]
none of this is a stock recommendation
[1020]
or a financial advice so you can now use
[1022]
this information to shortlist stocks for
[1025]
motor trading and murder trading is a
[1026]
short one-hour session during diwali
[1029]
that is considered auspicious and meant
[1031]
to bring you good luck
[1035]
again
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