What is a good or bad gearing ratio?

A gearing ratio is a general classification describing a financial ratio that compares some form of owner equity (or capital) to funds borrowed by the company. Gearing is a measurement of a company's financial leverage, and the gearing ratio is one of the most popular methods of evaluating a company's financial fitness.

Though there are several variations, the most common ratio measures how much a company is funded by debt versus how much is financed by equity, often called the net gearing ratio. A high gearing ratio means the company has a larger proportion of debt versus equity. Conversely, a low gearing ratio means the company has a small proportion of debt versus equity.

Read more at:
https://www.investopedia.com/ask/answers/121814/what-good-gearing-ratio.asp

Does large debt on the Balance Sheet make a company's stock a risky investment?

It is that time of the year when Annual Reports of companies will be hitting mailboxes. Instead of just checking the dividend amount and tossing the report in the recycle bin, it may be worthwhile to go through the report.

At the very least, the balance sheet, P&L, cash flow statement and the notes to accounts should be studied. These will reveal the financial health of a company.

One of the things that get many companies into trouble is trying to grow too fast, too soon. Many tech companies had fallen prey to the syndrome of 'grabbing eyeballs' instead of having a solid business plan that would lead to cash generation.

They had taken on a huge amount of debt to gain market share quickly by expanding globally or by acquiring competitors. Their subsequent bankruptcies were caused by the inability to service their debts.

Even the well-established houses of Tatas and Birlas made gross errors of judgement by financing their acquisitions of overseas competitor companies through large debt.

But what if taking on large debt to buy out a competitor actually results in increasing market share and enabling a move up the value chain? Tata Motors did that successfully by acquiring Jaguar-Land Rover from Ford.

So, how does a small investor decide if large debt on the Balance Sheet of a company makes investment in its stock risky or not? 

One way is to look at the Interest Coverage ratio. Another is to look at the Return on Capital Employed (RoCE) ratio. The higher the ratios the better. Both these ratios should be compared with other companies in the same sector.

Read more. 

Are sugar sector stocks turning sweeter? - a guest post

Most small investors will be wise to stay away from sugar sector stocks for several reasons. Like most commodities, sugar's price moves in cycles. That makes long-term investing a challenge. One needs to carefully time entry and exit to make money from sugar stocks.

The other major reason is government interference and price control. Sugar manufacturers are not always at liberty to decide whether they will sell in the domestic or export markets and at what prices. Government also dictates what prices producers have to pay farmers for their sugarcane produce. As an agricultural produce, weather plays an important role in sugar production.

However, experienced investors who are not risk-averse and are adept at timing their entry or exit can take a look at sugar stocks now. In this month's guest post, Nishit explains why the current water scarcity and drought-like conditions in several states may benefit stock prices of sugar companies. 

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Summer is a time of drought and water scarcity in many regions of India. While the main reason for this is deficient rainfall, the impact has been higher - especially in Maharashtra - because a lot of water has been diverted to water-guzzling sugarcane crops.

The most drought-affected areas are the sugarcane belt and Maharashtra Government has declared a moratorium on new sugarcane factories for the next 5 years. Sugarcane output may fall to 50% of what it was 2 years back in Maharashtra, which is supposed to be one of the highest producers of sugar within the country.

Sugar stocks are in the limelight and they should be. Lower production leads to higher prices. That means bigger profits for sugar companies.

In Maharashtra, the drought cycle will continue till the farmers switch to cash crops which require less water. Sugarcane farming will lead to more droughts. Often it takes a crisis for us Indians to act. We have a crisis staring at us right now in terms of drought.

The sugar cycle is a long cycle and the prices have still not gone up very much. Global sugar prices had peaked at around US $35 in 2011 and are currently at US $15 after touching a low of US $10.

With increasing population and lower production, sugar sector is looking up. One of the issues which need to be considered is the debt of Sugar Mills. During the last price rise in 2011-2012, this debt factor prevented many sugar stocks from gaining ground.

Sugar producing companies in the southern part of the country need to be looked at also. With water scarcity unfolding and production of sugarcane dropping, sugar sector stocks cannot be ignored.

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(Nishit Vadhavkar is a Quality Manager working at an IT MNC. Deciphering economics, equity markets and piercing the jargon to make it understandable to all is his passion. "We work hard for our money, our money should work even harder for us" is his motto.

Nishit blogs at Money Manthan. You can reach him at nish.stockid@gmail.com)

Stock Chart Pattern - Indian Hotel (An Update)

Fundamentally, the company is still struggling to come out of the woods. Mistimed acquisitions - overseas and in India - at the height of the previous bull market had left the company with a huge debt burden.

A global economic downturn followed by the terrorist attack in Mumbai severely curtailed visits by foreign tourists, and put paid to any near term chance of a revival. Overcapacity in the Indian market didn't help matters.

The lower-end Ginger brand hasn't been successful. A change at the helm and efforts to restructure and consolidate operations seem to be slowly bearing fruit.

Technically, the daily bar chart pattern of Indian Hotel shows that the worst may be getting over. The stock had touched a low of 37.55 on Aug 6 '13. The subsequent rally took the stock to a high of 127.25 on Dec 5 '14 - a huge gain of 240% in 16 months.

The stock touched slightly lower tops of 126.85 on Jan 2 '15 and 126.95 on Feb 5 '15 - forming a 'triple top' reversal pattern in the process. A 7 months long correction ensued, and the stock slid below its three EMAs into bear territory.

The stock price touched a low of 80.75 on Sep 7 '15 - testing the long-term support-resistance level of 80 - and retracing 51% of its entire rise from the low of Aug '13 to the high of Dec '14. Since a 50% Fibonacci retracement often marks the end of a bear phase, it was no surprise that the stock has been on an up trend for the past three months.

By convincingly crossing above its three EMAs with a volume surge on Dec 2 '15, the stock has re-entered bull territory. The 'golden cross' of the 50 day EMA above the 200 day EMA has technically confirmed a bull market.

Three of the four daily technical indicators - MACD, RSI, Slow stochastic - are looking overbought. ROC has corrected sharply from its overbought zone. The stock is undergoing a sideways consolidation - after which it may move up to touch a new high.

This may be a good time to start accumulating the stock.

Notes from the USA – a guest post

Three successive rounds of QE (Quantitative Easing) programmes has pulled the US out of a recession and on the road to economic recovery. Or, has it? While a recession has been prevented and the value of the US Dollar is reigning supreme again, the state of the economy leaves a lot to be desired.

Those who were laid off and failed to get re-employed are simply leaving the job market, or doing part-time work at lower pay. College graduates are not finding jobs. Education loans are remaining unpaid. People are paying down debt. Durable goods are finding few buyers. Without job growth, there can be no spending growth and no economic recovery.

In this month’s guest post, KKP gives a ‘ground zero’ view of the state of the US economy, and discusses the consequences of tapering down of the current QE programme.

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Good Comes After Bad and Bad Comes After Good Comes

We have been talking about the ‘money pumping’ that the US Fed has been doing for a few years now, to ‘stop the global economy from entering into recession’. Of course, money printing (buying bonds, actually) that has created a level of debt unprecedented by any economy, in any prior times is something that has been supported by politicians and government economists. Who can stop them? No one.

We all know what happens when there is TOO MUCH float in the hands of businesses and consumers. Inflation. Too much money chasing too few goods, right? Well, the Fed now realizes that the housing market is starting to turn a bit, although most of the housing turn is money that cannot sit at 0.01% annual interest, and that is pouring into Real Estate, showing the artificial demand for ‘housing’. What is not associated with it is the reduction in Foreclosures, Short Sales and also First Time Home Buyers. Most of the housing demand is ‘upgrading’ (if it is not ‘investors’ like me).

Let’s look at jobs growth…..Unemployment is coming down, but when the government stops counting the people who are NOT paid unemployment benefits, then you are counting less people entering unemployment, and you are dropping a large number of unemployed at the back end of the pipeline (ones who have run out of their 27 or 52 weeks of unemployment benefits). Bottom line, it is showing that unemployment levels have improved from 9.5%+ to just under 7.5% recently. In reality, the Federal Reserve Act calls for 'maximum employment', not 'minimum unemployment' which is a more popular phenomenon.

The quarterly GDP is coming out with decent numbers, but the subsequent revisions are always down. True inflation is much higher, but the numbers (like India) are being reported with some skew in it, showing 3% to 4%. If that is the case, and if I am even partly right about everything above, then why “stop the QE program”? See announcement below:

“Federal Reserve officials have mapped out a strategy for winding down an unprecedented $85 billion-a-month bond-buying program meant to spur the economy – an effort to preserve flexibility and manage highly unpredictable market expectations.”

As I said, all of this is Fed’s business with very little that we can do/influence. We just have to be proactive to their moves, since some people are calling this a bubble itself, built on a ‘house of cards’ that will not need much of a ‘phook’ (whiff of air) to crumble down quickly. Markets come down 3 times faster than they go up! Remember that adage.

As and when this happens, we will feel like being driven off the cliff, with the government driving, and of course, we are in a car without a parachute.

All of this started to show that ‘US is not going to run out of money in its massive $14T economy’. The economy has not improved from the $14T number at all, so what does Obama and Bernanke have to show with the additional $4T (to a debatable $6.5T) debt that we have amassed already.

The current buying of $45 billion a month of Treasuries is to fund the government and throw liquidity at the banks to flow to the consumers. If it did not do this, of course, rates would rise and therefore, we would owe more money through debt payments, and naturally, we would have to cut our spending (government, military, other programs etc). And of course, cutting back might also starve some of the credit programs through Fannie Mae and Freddie Mac (lenders for people to buy houses). Not happening. Therefore, it will be a slow cutback of the $45B and not a sudden shutdown.

A lot of this money is showing up as ‘excess credit’ at cheap lending rates through businesses and investors, pouring money into ‘investable real estate’ and ‘investable funds in stock market’. As a result, the real estate indices are going up, and stock market indices…..well you know (going to New Highs). Consumers are feeling good, and saying that Fed has averted the ‘bad times’ and we are ‘off to the races’. Barrons, Times, Forbes, Wall Street Journal etc are all printing this positive news and smaller investors (retail) have been calling me again to find out what to invest in. Gold going down simultaneously is also part of the same move, squeezing the ‘inflation believers’ out of commodities, by putting funds into equity investments.

In reality, with this news coming out, the markets got affected a bit, but it seems we are stabilizing. Fed wins again in its move. If the support of the parent is moving away, will the child fall down again? We are in for a wild volatile ride, and Asian markets will ride up and down with this.

Keep your eyes open, and let your fingers itch to get out of the non-long-term positions……Protecting capital is a key to success.

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KKP (Kiran Patel) is a long time investor in the US, investing in US, Indian and Chinese markets for the last 25 years. Investing is a passion, and most recently he has ventured into real estate in the US and also a bit in India. Running user groups, teaching kids at local high school, moderating a group in the US and running Investment Clubs are his current hobbies. He also works full time for a Fortune 100 corporation.

Notes from the USA (Jun 2012) - a guest post

Ever since the sub-prime crisis brought the US economy down to its knees 5 years ago, the equilibrium in the global economy got badly disturbed. Growth in China and India kept the global economic engine under control for a while, but once the sovereign debt contagion spread across the Eurozone, things have once again taken a turn for the worse. Stop-gap measures through quantitative easing and debt bail-outs have prevented a global economic collapse for the time being, but underlying problems are yet to be solved.

In this month’s guest post, KKP quotes from an IMF paper about prudent levels of debt-to-GDP ratios that different countries should maintain for long-term sustainability of their economic growth.

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Economic Prosperity based on GDP and Managing Debt

America used to be thought of as the land of opportunity, and we had a lot of debate lately on when US may lose this status. The fact that we are debating means that there is more agreement than disagreement. US constituents worked hard to create the popularly called “American dream of opportunity”, but today, that dream is becoming a dream that we see early in the morning (the one that comes true eventually)!

USA can become a land of opportunity but it cannot become one with the current state of the economy, jobs, politics, educational programs, government spending, and divergences of the top, middle and lower classes. So why do you think that US has got itself into this situation in the first place? To understand that, we have to get into the topic for this month: Gross Domestic Product and Debt Levels.

We had a ton of debate on gross domestic production measures, total ownership of debt by government and maintaining a healthy profile of a country. Well today, a lot of these values and absolutes are being challenged. So, what are the proposed prudential limits on public-debt-to-GDP ratios, and how important is its role for a bright future (of any country)? Based on work put out by an IMF study, a debt-to-GDP ratio of 60% is quite often noted as a prudential limit for developed countries. This simply suggests that crossing this limit will threaten fiscal sustainability/stability, as we are experiencing now in the USA. For developing and emerging economies, 40% is the suggested debt-to-GDP ratio that should not be breached on a long-term basis. Again, this is being challenged by many of the PIIGS and look where that has brought us with those countries (they have their hand out).

It is really a question about how a government, whether in a developed or a developing nation can sustain high debt levels (with respect to their internal production, a.k.a. GDP), and maintain a threat-free environment to economic growth in most sectors of the economy. Fiscal policy in any country has to ensure that its macro-economic model allows for the slow and upward slope of the business cycle, while sustaining an ability to pay for the debt within reasonable rate structures (bond yields); all of it without a major compromise on the underlying strength of the currency. If any of the three angles of the triangle are violated, there is a negative effect on the stock market, and the economic boom expected by its constituents, shaking the confidence of the society (business and personal).

The big question is if the 60% and 40% figures are optimal, sustainable and still works for the ensuing decade. Currently, we see a lot of countries violating these levels grossly, with no realistic target to improve its situation in any major way to return back to these levels recommended by the IMF. In fact, in my opinion, there are countries learning how to ‘challenge’ that thinking and create a domino of patch-work that will band-aid the problem, without resolving the root-cause. Let us look at the current levels of debt/GDP for a few countries:

Prudence from the IMF paper dictates that countries target a debt level well below the limit on the grounds that getting towards the upper end will challenge the stability and also the solvency of a given country. We are experiencing this about Greece, and we had a lot of debate on various Indian Forums about solvency of USA in a similar manner. In reality two key factors affecting solvency are the response of primary balance (i.e. budget balance net of interest payments on the underlying debt) to increases in debt level and the possibility of adverse shocks to the economic system. As we have seen for Greece, it is assumed that when debt gets very large, it may be difficult to generate a primary balance (positive number) that is sufficient to ensure sustainability of the economy; the shock from which pushes a country beyond their debt limits. The underlying debt needs to be sold at unbelievable yields to attract risk-funds (who will give up their precious cash to buy the bonds of a country that may dissolve!). Hence, the advice is to remain well below the limit for the sake of prudence (liquidity levels, rollover risks and also future growth). Liquidity is not an issue for domestic debt as it can always be paid off by printing money, a sovereign right which households or firms do not have, and a practice that the US is teaching the rest of the world by putting its stamp of approval on its own practices.

On a side note, inflation necessarily does not result from doing so initially, but when the growth engine gets in gear, the amount of money in circulation from all the printing, availability of credit to businesses and individuals, and of course, the open money supply available, will totally wreak havoc to the nation’s future. Currency takes a dive and buying power get diminished (Zimbabwe is the poster child).

These are macro events, and do not topple the next dominos within weeks or months, and yet, when the Titanic does turn (in 1-2-3 years), it will finally face the boulder of inflation with a depreciated currency, which the US will not be able to avoid without some dramatic side-effects. Every country, however small or big, is a Titanic by itself. We all have to watch over our investments to ensure that we are not facing the zero to negative percentage returns as is the case for Japan for the last decade, which has grossly violated the prudent practice of being under the 60% marker (graphic above shows that they are at 200%+).

India has a long way to go, but it will face these times when it really gets into gear to ensure that its infrastructure, government/business practices and of course, the growth model produces high organic-growth with significant government borrowing behind it. Let us continue to watch for it and ensure our portfolios stay in check to ensure double digit positive returns to our portfolios in a low single digit inflation environment (with a stable currency)……..Is that a lot to ask?

Please post your views….

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KKP (Kiran Patel) is a long time investor in the US, investing in US, Indian and Chinese markets for the last 25 years. Investing is a passion, and most recently he has ventured into real estate in the US and also a bit in India. Running user groups, teaching kids at local high school, moderating a group in the US and running Investment Clubs are his current hobbies. He also works full time for a Fortune 100 corporation.