The Key to Sustainable Growth
The Key to Sustainable Growth
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Most companies truly suck. This can stem from various things: bad business models, deceptive management, no revenue, etc.
And yet, these “enterprises” still get listed on the stock market. How, you ask? Complex methods of concealing turds for raisings.
These days, a business with a good story can easily be worth a few billion dollars - even if it's not profitable, and even if its future isn’t sustainable.
We’re all human beings who are easily lured in with promises of endless riches. But, as we have seen in 2022, investing in these “bright” companies can quickly turn dark.
“Only when the tide goes out do you learn who has been swimming naked.” – Warren Buffett
In this article, I’ll teach you my easy method of avoiding companies that could sink your portfolio.
But first, you need to know how a lemonade stand works.
When Life Gives You Lemons
Once, a young boy named Jimmy crafted a lemonade stand with wood he found in his backyard, guided by his skilled grandfather. Across the way, Frank chose an easier path, borrowing money to buy a stand.
They both thrived, selling lemonade until autumn's arrival dampened demand. Jimmy stored his stand for the next summer, while Frank, burdened by debt from his stand, was compelled to sell it, ending his lemonade venture for the next year.
The lesson? Equity over debt
Investors love durable businesses. And debt is the enemy of longevity.
When a business is expanding it really only has two main options:
1: Use profit
2: Borrow money
Which option is best? In simplified terms, companies that use their profit to grow can live forever.
That’s because playing with your own money is always carefully thought out. Plus, you don’t owe anything to anyone if things go south.
That being said, most publicly listed companies try to balance both. Their size allows them to.
But once you start throwing borrowed money at your problems, things get dangerous.
Too Much Debt?
Sooner or later, you have to pay back what you owe. That will impact the bottom line and the stock price with it.
Here are a few companies struggling with debt.
I know what you’re thinking. How do I avoid such companies?
The Debt-to-Equity Ratio
The debt-to-equity ratio simply looks at how much of the company's money comes from borrowing (debt) compared to how much comes from the owners (equity).
Debt-to-Equity Ratio = Total Debt / Total Equity
Determining a "safe" level for the debt-to-equity ratio depends on various factors, including the industry the company operates in.
A ratio below 1 or close to 1 might be considered safe in stable industries.
However, in unpredictable industries such as tech, even the smallest amount of debt can sink a company.
So, make sure you always have an eye on how the company is funding future growth. Debt risk is silent. Until it’s too late.
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Information provided on this site is based on my own personal experience, research, and analysis, and it is not to be construed as professional advice. Please conduct your own research before making any investment decisions. I am not a professional financial advisor, stockbroker, or planner, nor am I a CPA or a CFP. The contents of this site and the resources provided are for informational and entertainment purposes only and do not constitute financial, accounting, or legal advice. The author is not liable for any losses or damages related to actions or failure to act related to the content on this website.