Invest in businesses with net cash or net debt?

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During the last one and a half decades, it nearly didn’t matter to look at a company’s balance sheet. The reason was quasi non-existent interest rates – a historically unprecedented scenario, not only for the younger generation. Hence, it is no wonder that those who held too much cash in their books even got punished by not receiving any income on their deposits. On the other hand, debt-hungry entities got subsidized. However, the winds have changed. Interest rates are up dramatically. What are the consequences?

Summary and key takeaways from today’s Weekly
– While during the last one and a half decades many companies borrowed money cheaply to repurchase their own shares or to hikes dividends (or for acquisitions), among them are cases that took too big bites to swallow.
– The bill is now on the table – deleveraging and less shareholder returns, even dividend cuts are “surprisingly” coming.
– The topic of having net cash is still not discussed frequently enough, although the benefits are clear.

I know that the majority out there does not care about this topic.

However, it is so crucial that it even can save you from many disappointments which are waiting around the corner. While during the zero or near-zero interest rates environment nearly everything rose and many traditional fundamental analysts or value investors looked like idiots, I’m highly convinced their time has come back again.

Interest rates did always matter, but they matter even more, again.

The reason is that those who gambled on a continuation of historically low interest rates are slowly receiving their bill. Respective shareholders are also slowly starting to feel the pain, as dividends are in danger or even already cut while equity prices of highly indebted companies are hovering around multi-year lows – LOWS, not highs.

Or at best somewhere in nowhere’s land.

I’m not saying this as a fear-monger, but as a realist and someone who likes to dig deeper into the financials of a business. I am a risk-focused fundamental investor.

Scanning through headlines for some adjusted EBITDA numbers is not sufficient.

While many analysts – if at all – only quickly look at metrics like EV / EBITDA, debt to equity or the total amount of debt in relation to free cash flow which are fine but not entirely useful on an isolated basis, often I don’t find anything about rising cost of debt, refinancing that has the potential to completely cripple companies, not to mention foreseeable dividend cuts to save the existence.

The difference is that the former approach is static, while the latter is dynamic.

Taking the past as given is obviously not the same like factoring in new developments and playing around with some probabilities that are tilting from in your favor towards against you, is it?

source: Gino Crescoli on Pixabay

Have you known that the fastest growing position in many P&L statements of companies operating with debt are interest payments (cost of debt)?

Unfortunately, many people don’t care about what could (with an increasing likelihood) happen – until it happens! And then they are “surprised”, because a dividend has been paid and / or raised consistently over decades.

Until it hasn’t anymore! The sad thing is, these are no sudden accidents, but often foreseeable developments already in the making.

As my longer-term readers know, I am not a backwards- or yesterday-investor.

Of course, I am looking at historical figures, too. Every publication of the latest financial results only shows what happened in the past even if it was just a quarter ago. As I haven’t mastered forecasting (yet), I am too not able to exactly write down in advance what comes next and especially when.

But one can use common sense together with probabilities and the big picture.

The question of “net cash or net debt?” is often either viewed as bean counting or details that don’t matter in the big picture. But today, I am going to show you why it matters by going through some real-world examples.

I’m sure understanding this topic will help many to check and clean up their portfolios.

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Why net cash wins again and some examples

I could simply write a sentence with reference to the famous fund manager and someone who deeply influenced me, Peter Lynch, that a company without debt cannot go bankrupt.

But first, I would need to add that a positive cash flow is necessary, too.

Otherwise a cash-burning entity absolutely can go under, even having no debt. Just think of unprofitable start up businesses where the balance sheets consist of (raised) equity. To be fair, Lynch referred to profitable businesses.

And second, the message I want to deliver today would fall short.

The shortcut, namely from now on avoiding companies with any debt, is a possible way to solve this. But that’s not what I would prefer, as there are interesting companies with low and well manageable debt. I want you to better understand certain mechanics behind my analysis process that can be beneficiary to you.

So, let’s start with the construction of a typical profit and loss statement.

In this case, I just took Home Depot (ISIN: US4370761029, Ticker: HD) as an example. Not because, it is a candidate for a bankruptcy – far from it. But using it, I can show you all my important points in an illustrative way and explain why despite its high debt load the balance sheet is not damaged too much.

However, it is not interesting for me, either, as I’m going to show you.

What you should know at this stage is the following abbreviated order: sales, gross profit, operating profit, net profit. In between each, you have certain, but different types of costs that operating the business causes.


Highlighted above in gold is the line of interest expenses or cost of debt.

It sits between operating earnings, also called EBIT (earnings before interest and taxes), and the bottom line, also called net earnings or just profit. The reason for this positioning is to showcase the core earnings strength of the underlying business by looking at operating earnings, assuming a capital neutral structure.

While fine for a first impression, of course you cannot stop here, ignoring the lines below. Especially when you can find out that interest expenses are rising like in this case, thus hurting the bottom line. But that’s only half the truth like we’ll uncover soon (and where strangely many stop analyzing).

Next, please have a look at the development of net debt* (black) and equity (blue) on the balance sheet of Home Depot.


*companies did not have to disclose leasing separately prior to 2018/2019. Also platforms like TIKR often put financial debt and leasing together. For simplicity reasons, I used TIKR’s total net debt numbers.

You can see immediately a rather typical development of companies that heavily made use of the low interest rate environment by massively and cheaply borrowing.

In the case of Home Depot, it even started with a balanced debt to equity ratio. Thus, the first correlation is “higher debt = higher interest payments”. While not wrong per se, this is not enough for a conclusion or even an investment decision.

The good thing is that most companies borrowed at mostly fixed interest rates.

And here it gets critical, because rising interest rates only slowly bite into the financials of a company until debt has to be refinanced or is paid back.

Although I don’t think that Home Depot is in danger of getting bankrupt, there are two ramifications – both negative for shareholders – one should be aware of.

The in most cases fixed rates are the protective umbrella so far why many companies have not dropped dead, yet, despite massively higher central bank interest rates. A company that was able to borrow for 2% or even less, will be happy to now place a bond at 6% – tripple of that!

Just to remind you:

sourde: FED St. Louis (see here)

Certainly the worse of the two, for those companies that cannot repay their debt but rely on refinancing, as it will have to be refinanced at way higher rates than in the past, obviously the cost of debt will increase.

And not slightly, but meaningfully.

This in turn will hurt the bottom line – and cash flows. You have to understand that there are many companies out there that borrowed massively to appease shareholders by making special gifts in the form of dividends and buybacks that sometimes even were more than the underlying business was able to generate in cash flows!

That’s the summary of the story, now the facts.

First, cost of debt. A simple calculation of the cost of debt divided by total net debt for the respective fiscal year of Home Depot, gives us the following results:

  • fiscal 2014: average cost of debt was 5.5%*
  • fiscal 2023: average cost of debt was 3.4%
  • last twelve months: cost of debt was 3.8%

*companies did not have to disclose leasing separately prior to 2018/2019. Also platforms like TIKR often put financial debt and leasing together. For simplicity reasons, I used TIKR’s total net debt numbers.

You see that the cost of debt slowly starts to rise again. Well, actually it’s already 10% higher just half a year later which is a big leap forward (in a negative way).

Looking into the most recent quarterly report, we can see that interest expenses have risen by mouth-watering +23% comparing this year’s with last year’s quarter, respectively by +25% when comparing the semesters.

This is the fastest growing category in the P&L statement.

Is it any wonder that despite sales and gross profits going sideways, net profits dropped disproportionately by double-digits?

source: Seeking Alpha, Home Depot 10 Q for fiscal Q2 2024 (see here)

Companies that structured their debt in a favorable way, don’t have to necessarily refinance at higher rates. In the case of Home Depot, we can see below from the last annual report that only a few billions are due each year and luckily not a big wall (of the size of say 5 bn. USD or so) in a single year.

For a company generating strong cash flows like Home Depot, this effectively means they can pay their debt back, even lowering their interest payments again over time.

Refinancing would likely result in 2–3x higher interest rates, sometimes even more.

source: Seeking Alpha, Home Depot 10 K for fiscal 2023 (see here)

Now, point number two – the blemish and what to be aware of down the road.

While I don’t think that Home Depot will have bigger challenges with their debt, shareholder returns from now on should be rather limited.

Again, a table from TIKR where we see – each over the last ten years – the free cash flow (blue), stock buybacks (black) and the dividend (green):


What’s the matter?

Between fiscal 2014 and 2019, HD in total repurchased more shares and paid higher dividends on a cumulative basis than their generated free cash flow was. That’s where the debt went they loaded up during this time and also the reason why equity shrank.

Fiscal 2020 was an outlier with high uncertainty, but in fiscal 2021 and 2022 again the same. More payouts than free cash flow.

But now interest rates are higher, increasing the cost of debt.

This means and assuming HD manages to generate around 10 bn. USD in free cash flow yearly that after spending 8 bn. USD on the yearly dividend and having to repay debt from now on (or refinance at higher rates, effectively lowering cash flows) there will not be any meaningful financial means for buybacks anymore.

It could even go as far as that the dividend will only be kept stable or hiked symbolically as the survival (repaying bond holders) has a higher priority than a last dance (shareholder gifts). It is nearly safe to assume that the more than 5x of the dividend from 1.56 USD to 8.36 USD p.a. over the last ten years would be a way too fast pace from here on to proceed.

As said, I think the Home Depot is not in immediate danger.

However, don’t expect too huge returns from here on, as they repurchased 30% of their stock outstanding over the last ten years. This won’t happen again, as they’ll likely protect their dividend first. A dividend yield of less than 3% is not compelling, either, in the current environment. Plus, with an EV / FCF of c. 30x I don’t see any reason for above average returns from here.

source: Pexels on Pixabay

Now, as we went through the fundamental basics and mechanics of a company that is not in danger of either going under or even axing its dividend (at least for the foreseeable future), I want to discuss some more cases and apply this critical view.

The first is a set of two companies that were praised as great dividend investments, where many pundits saw great buy-the-dip opportunities and juicy, safe dividends one should not let slip through their fingers.

  • V.F. Corp. (ISIN: US9182041080, Ticker: VFC) is already known to my longer-term readers, as I head-shakingly explained why its 42% dividend cut was foreseeable. You can find those three Weeklies here, here and here.
  • Number two which recently at the start of this week cut its dividend nearly by half is the REIT (real estate investment trust) Medical Properties Trust (ISIN: US58463J3041, Ticker: MPW), an owner of clinics and hospitals.
source: Seeking Alpha (see here)

I did not feature it in my top candidates for a coming dividend cut, but I wrote several times on Twitter (now: X) about its weak finances and the unsustainable payout.

Its dividend was supposed to be safe and even ready to be raised further due to a too low payout ratio (c. 75%), as many “analyzed”. Before the cut, the dividend yield was as high as 16%. Now, after the announcement (see here), it is close to 9% which of course is still quite significant.

The reason: A way too high debt load.

And unlike in the case of Home Depot, a few big walls are coming over the next years that cannot be paid back while keeping the dividend as was at the same time.

MPW has an “adjusted” net debt to EBITDA ratio of 7x which is already not low. Add to that a ratio of 14% of debt outstanding having variable interest rates, meaning they rise immediately in tandem with the central bank interest rates.

Below, you can see MPW’s coming debt maturity schedule.

Keep in mind that MPW generates only c. 800–850 mn. USD in adj. funds from operations (the REIT number for their operating results), respectively only around 100 mn. USD after the old dividend was paid. More expensive refinancing would have eaten them alive. And selling hospitals, a special type of real estate not as liquid as other property types, under pressure wouldn’t be the full solution either.

source: MPW Q2 results, supplemental material (see here)

To be honest and ignoring the fact that some of their tenants have liquidity issues, I am not fully convinced that this is enough to handle the maturities starting from 2025.

It rather looks like a small breathing pause.

There are voices that the bad news are now public and priced into the stock. However, I would be cautious.

If you are interested in companies where I see high risks and even likelihoods of coming dividend cuts, you can have a look at my Weeklies here, here and here.

With Intel (ISIN: US4581401001, Ticker: INTC) I was right.

Where I am waiting for lowered dividends are, among others, darlings with debt issues like 3M (ISIN: US88579Y1010, Ticker: MMM), Digital Realty Trust (ISIN: US2538681030, Ticker: DLR) or AT&T (ISIN: US00206R1023, Ticker: T) and Verizon (ISIN: US92343V1044, Ticker: VZ).

source: Dmitriy on Pixabay

Now, I want to have a look at the other side: Net cash.

Why buy something troubled with disproportionately higher risks when you can enjoy tailwinds? Tailwinds like extra income from deposits or short-term bond investments?

In my exclusive reports that I frequently send to my Premium and Premium PLUS members, I put a high weight on sound finances and a strong balance sheet.

Having a net cash position is not a strict requirement for me, but sometimes one can find true gems. Below, you can see the covers of two such reports where the businesses have extremely high cash positions in their books.

To be clear, these are both highly profitable businesses that are now – thanks to their conservative finances – earnings extra income, simply by having excess cash.

The following data is taken from TIKR.

The first has an insanely c. 88% of its total assets (!) in cash. Unfortunately, the second screenshot shows numbers as of 31.12.2022, because this company is only reporting full numbers semi-annually. This means, these numbers include H1 2022 where interest rates only started to rise.

Next week, when they update on their last semester, I expect to see a positive interest income, as management is holding cash, without investing it.

The second case has “only” c. 40% of its total assets in cash and short-term bonds (also earning interest):

You can see that this company is already earning extra income. As their older bonds come due, this income should increase further.

Just to illustrate, with this 50 mn. of “money for nothing”, the company in question could repurchase around 0.5% of their stock outstanding at current prices – without touching its cash reserves (!).

I think being liquid and having excess cash, especially in an uncertain environment is not the worst strategy.


While during the last one and a half decades many companies borrowed money cheaply to repurchase their own shares or to hikes dividends (or for acquisitions), among them are cases that took too big bites to swallow.

The bill is now on the table – deleveraging and less shareholder returns, even dividend cuts are “surprisingly” coming.

The topic of having net cash is still not discussed frequently enough, although the benefits are clear.

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