The writer had shared before on net cash companies, stating that companies that have a lot of cash is like having an extra bonus on their business. However, the writer also mentioned that net cash companies are not necessary the best option, and we can also sometimes consider to invest in net debt companies. The rest of this article will state the reasons.
First, we will need to find out what caused the companies to bear this huge amount of debt, is it due to the capital expenditures that the company did, or is it because the company would like to pay dividends to their fellow shareholders? We will first talk about the first one. There are companies who have not enough money to complete their capital expenditure and have no choice but to borrow from banks. Examples given here are HARTA and SCGM, both companies are net debt companies in FY2019, and HARTA has turned to a net cash company in FY2020, and is able to repay more borrowings after the surge in glove price.
We can see that companies that undergoes capital expenditure will have their profit reduced due to depreciation. This can be shown as HARTA’s revenue increased in FY2019 but its profit remained stagnant, and SCGM’s reported a loss in FY2019 despite its revenue improve compared to last year. Hence, the more capital expenditure a company did, the more the company will have their profit deteriorated by depreciation.
On the other hand, there are some companies that tend to borrow money from bank, just to pay dividends to their shareholders. This is because dividend is one of the element that attract investors, especially dividend investors. Hence, investors that do not look into a company’s report will fell into this dividend trap, where the companies are just using other people’s money to pay the dividend while the company itself is unable to repay these debts. These companies shall be avoided at all cost, because this means that the company is unable to generate profit and convert it into cash. Without sufficient cash, the company will not be able to pay dividend hence discouraging fellow investors to invest in their company.
In short, net cash companies are definitely a good sign for maintaining their healthy cash flow, but we should not disregard net debt companies too. All we need to know why are the company facing such debt, and what are the reasoning behind. If it is for the company’s future, it shall be a good buy when others have yet to realise this company. However, if it is not, we shall then avoid these types of company at all cost.
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