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VALUE INVESTING
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I have written before on the subject of debt and value shares. Debt, the lack thereof and its direct opposite, cash in the bank, is a key element of my own four pillar strategy as most readers will know (I probably should have called the strategy 'PYAC', but that sounds too foreign). Not all value investors agree on this and many are willing to accept a reasonable level of borrowing, "gearing" if you want to get technical, "leverage" if you want to get yank technical. After all, a share with a low price to earnings (P/E) ratio, high yield and low price to book (P/TB) may still be an attractive value share, even if it has some debt. My views, as with most investment matters, differ from a lot of other investment writers on the question of how much debt may be acceptable. Because I invest in a small number of shares at a time, I have to reduce my risks as much as possible; "minimise the downside" in the now clichéd phrase. The more debt a company has, the greater the risks it presents to an investor. Debt is usually what drives companies to bankruptcy in extreme cases, making the shares worthless. Cash, on the other hand, I find highly attractive. I doubt any company ever went bust through having too much cash. I find it most peculiar that some investors and commentators object in some way to a company holding cash, and would rather it was invested in an acquisition perhaps. For me, a company in which I am invested making an acquisition usually has a large neon EXIT sign above it -- for the simple reason that most acquisitions go wrong. This is why the shares of bidding companies frequently do badly for quite a time after making sizeable acquisitions. Knowledgeable investors are not willing to grant the acquirer the benefit of the doubt and may face dilution of their equity. Even worse are those writers that claim that a certain level of debt is a good thing for tax reasons or academic studies suggesting some sort of optimum mix of debt and equity financing for a business. Here is the optimum mix of financing in my business school theory: Debt 0%. Equity 100%. Cash? Yes please. The reasons are clear. Debt requires servicing, whatever the state of the business. Had a bum year? Still have to pay interest. Equity, on the other hand, requires no contractual return. The company may pay a dividend which it can alter at will. Personally though, I would rather they alter it only one way -- up. Value investors frequently demand a good yield, and I personally always do. Having plenty of net cash permits a more generous and maintainable dividend policy. And yes, I am aware that gearing will enhance profits in the right circumstances. But it can also have precisely the opposite effect in the wrong ones. And the wrong circumstances are what I consider first with any investment. The fact is that the great majority of companies have net debt and not net cash. And don't forget, the cash position will only be as good as the latest reported figures, which may be a year old if you are using a data source that updates only on annual accounts. But you can always get hold of the latest interim report if you are interested. Read the directorspeak, it may give a clue as to what the company intends to do with the money. Generally though, cash really is the most wonderful stuff of which most of us can never get enough. Consequently, it is far too parochial to show the monarch's likeness on the currency. Showing God's would be a better idea.