Avoid high debt companies

During the bull market, many companies are growing at an extraordinary rate. The only way to fund such growth is to raise capital. A company can raise capital either by equity dilution or by taking loans. It is much easier to go with the second option. As long as the growth momentum continues, there is not a serious concern. The problem starts once things turn around. Suzion was of the favorite stocks during the bull market. The company operated in the renewable energy sector that was considered as a next big thing. Everything was fine. Stock prices doubled in 2007. Unfortunately, excessive hunger for growth increased debt burden. The company went for costly acquisitions which stretched their balance sheet. The company later fell into a debt trap. Huge interest outgo minimize the profit. The situation started to worsen. An increase in its working capital requirement and massive debt from RE power acquisition led a further increase in its total debt. Since 2009, the company has continued its tale of posting loss. No wonder from the high of January 2008, the stock price dipped around 95% over the next four years. Suzlon, once the darling of the stock market, turned to be one of the biggest wealth destroys of the decade.

Stay away from high dent companies at all cost. The easiest way to find companies with high debt is to check the debt to equity ratio. Increasing debt to equity ratio is an alarming situation. Avoid companies where the debt to equity ratio is more than 1 and the interest coverage ratio is less than 3.