A high interest cover ratio puts a company in a more comfortable position. If a company can’t pay interest, it has two options: it can seek more financing from outside sources or issue new equity, which will make the current shareholders own less of the company. Interest Cover If there’s debt in a balance sheet, then I want to make sure the company is able to repay it. This ratio may be negative when companies carry more cash than borrowings, as net debt discounts cash holdings from the debt load. I’m looking for companies with a strong financial position that can withstand difficult times without facing financial difficulties due to excessive borrowing. To select companies with just moderate leverage, I use the 12-month trailing ratio of net debt-to-enterprise value. The FED hiked its rate by 500 bps in one year, which translates into a heavy burden for companies with high debt loads. If cash is king, debt is a thorn, particularly when interest rates are rising. In comparison to the P/E ratio, this ratio also replaces net profit by operating profit, a metric that is less exposed to manipulation. However, instead of considering the equity value, it takes into account the value of the whole corporation. This is a value filter similar to the P/E ratio. At the same time, these filters should preferably be easily implemented. I need filters that capture companies with strong balance sheets that have low debt and can provide good returns on capital. There is no specific set of filters available to effectively capture companies that possess both value and are debt-free. So, let’s define a few stock filters and select a portfolio for the upcoming correction. If you prefer the ETF way, you may wish to look at my last blog instead. For that sake, I’m using a quantitative strategy instead of buying an ETF. A good night’s sleep is worth more than the remaining upside in growth stocks. With all the above ideas in mind, I prefer to seek for value and sound balance sheets and eventually miss some of the potential upside. Therefore, paying interest and servicing debt will become a heavy burden for many companies, particularly if the economy loses strength. Even if the Fed and other major central banks stop hiking rates, I would not expect a reversion of policy anytime soon. Moreover, many of the stocks investors are buying have poor balance sheets and huge debt loads. As I exposed in my last blog, I believe value will prosper in the near future over growth, as interest rates start biting. But investors are fascinated with the strong bet on AI from these companies and are taking onboard to benefit from the trend. But, I find it strange to combine megacap and growth, because mega companies tend to focus more on reshuffling existing technologies rather than on true innovation and rapid growth.
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