If you were watching the financial news lately you would have heard about a company called IL&FS Transportation Networks which defaulted on its interest payments. It is an infrastructure company which builds roads and bridges.
You as an investor could have easily known back in 2016 that IL&FS Transport was a bad company and not to invest your money in it with just 5 mins of research.
Building infrastructure needs a lot of money upfront, so the infra companies need to borrow money from banks and other financial institutions and even the general public. The company lets say builds the road and gets the money from govt once its done or the company can collect revenue in form of tolls from public. So money goes out fast while revenue comes in slowly. Managing such a business model is not easy.
Debt to Equity
Looking at the debt to equity ratio in 2016 it was very high at 3.8 in 2018 its much higher at 6.1. A debt to equity ratio above 1 is not a good sign. A ratio above 1 means the company is taking more loans compared to its equity. Big loans means big interest payments.
Intangible Assets and Goodwill
Another major red flag and a metric to measure the managements honesty is looking at Intangible assets and Goodwill. Intangible assets and Goodwill are those assets which cannot be given a proper value. e.g If a company has a patent for a product or a good brand name (like Coca Cola), its definitely an asset but there is no formula to come up with an actual value for such assets.
If a company acquires another company for 100 million Rs but the value of its actual factory, machinery, land etc was 800 million Rs yet the company paid 100 million and it needs to balance the balance sheet so allocate 200 million as Goodwill. The goodwill is the premium you are paying for the brandname of the company being acquired which is why you ready to pay 200 million more.
Coming back to IL&FS, in 2016 its goodwill and intangible assets were 207,301 million Rs while its Total Assets were 378,443 million Rs which means around 50% of its assets were intangibles not some actual physical assets.
If you were a member of Craytheon you would seen this red flag in the company analysis section right away back in 2016.
You can save yourself lot of headaches and save your money by not investing in such bad companies by doing some basic research first.
P.S – Please do not call us for investment advice or stock tips.