With an uncertain market scenario and speculations rife over a rate hike by the Fed, companies with a low debt level are undoubtedly the safest bets.
Upbeat domestic economic data coupled with 242,000 job additions in Feb 2016, easily surpassing the consensus estimate of 194,000, have lifted the U.S. GDP growth estimate by 1%. Meanwhile, such a bullish economic backdrop might encourage an interest rate hike.
In case of a sudden raise in rates, companies with a higher debt burden will face the brunt as it will escalate the company’s borrowing costs and deplete its cash reserves.
Over the last three months, both the S&P 500 and the Dow Jones Industrial Average have gained 1.4% and 2.03%, respectively, indicating irregular stock movement. Hence, picking stocks with low debt levels will certainly help investors safeguard their portfolios in the wake of the market uncertainties.
Benefits of Low Debt Levels
Expansion: A favorable debt position allows companies to set aggressive expansion goals through the execution of mergers and acquisitions as it can borrow enough cash from the market while keeping its cash reserves intact. Moreover, a strong balance sheet will encourage the company to accelerate capital expenditure thereby driving market traction.
Shareholders Value: A low debt position implies reduced interest payment and cash position strength. Thus, the availability of excess cash with the company helps in enhancing shareholders’ value through dividend hikes and share repurchase plans.
Mitigates Risks: Investing in companies with a higher debt burden is likely to be a risky venture. During phases of economic downturn, a company having debt-free or low-debt balance sheet always reduces the chances of bankruptcy.
However, a lower debt to equity ratio indicates that a company is highly dependent on equity as a source of financing. Moreover, debt, as a source of financing, tends to be cheaper than the cost of equity.
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