Debt Risks: Is Your Investment Safe?

Hello investors!

Today, I'm thrilled to delve into the intriguing realm of company debt analysis. This is not just a mere accounting exercise, but a window into understanding a company's financial health and its long-term prospects.

In todays letter

• Learning: Debt Risks - Is Your Investment Safe?

• News insights

  • Meta's News Chief Campbell Brown Bids Farewell: End of an Era

  • Buffett's Firm Sheds 5M More HP Shares

  • European Property Funds Teeter: Real Estate Under Strain

• Key takeaways from Aswath Damodaran's video - Sports Franchises as Trophy Assets

Debt Risks: Is Your Investment Safe?

Company debt analysis is the systematic examination of a company's borrowing and its capability to meet those obligations. In essence, it's a litmus test for the risk associated with a company's financial leverage.

Case Study: Apple Inc. Apple, known globally for its iPhones and MacBooks, is also interesting from a debt analysis perspective. In 2019, Apple had a long-term debt of approximately $91.8 billion, up from $93.7 billion in 2018. Though these numbers seem high, it's essential to consider Apple's massive cash reserves and consistent revenue streams. Their ability to generate cash flow surpasses their debt obligations, making the company a safe bet for many investors.

What Buffett Says: Warren Buffett, the Oracle of Omaha, has always emphasized the importance of understanding a company's debt. He believes that companies with a fortress-like balance sheet (strong and low debt) are better positioned to navigate economic downturns. Buffett's long-time partner, Charlie Munger, echoes these sentiments, stressing the need for businesses to operate within their means and avoid over-leveraging.

5 Key Aspects to Analyze Company Debt:

1. Debt to Equity Ratio: This ratio compares a company's total debt to its total equity. A higher ratio can indicate higher risk, as it might signify that the company is financing its growth with debt.

2. Interest Coverage Ratio: It measures how easily a company can pay its interest expenses on outstanding debt. A higher ratio is better, indicating that the company can easily meet its interest obligations.

3. Current Ratio: This ratio compares a company's current assets to its current liabilities. It gives a snapshot of the company's ability to pay its short-term obligations.

4. Long-term Debt to Capitalization: This metric gives you a percentage of a company's capital structure that comes from long-term debt. A lower percentage might indicate a more financially stable company.

5. Net Debt to EBITDA: This ratio looks at a company's leverage relative to its earnings capacity. A lower ratio indicates that a company can pay off its debt quicker.

Another Example: Netflix, in recent years, has taken on significant debt to finance its content creation. By the end of 2019, their long-term debt stood at around $14.76 billion. However, their strategy of creating original content has paid off in subscriber growth, justifying this debt to some extent. Still, the high debt level is something investors should watch closely.

Understanding company debt is not just about looking at big numbers on balance sheets. It's about interpreting what those numbers mean in the larger context of business strategies, market conditions, and future prospects. As value investors, like Buffett and Munger emphasize, a deep understanding of a company's financial health is paramount to making informed investment decisions.

News insights

Meta's News Chief Campbell Brown Bids Farewell: End of an Era

Campbell Brown, who spearheaded Meta's venture into news, is departing from the company. This move signifies Meta's shift from emphasizing news content to concentrating on entertainment and viral trends.

[📝Full article]

Key takeaway

Brown's exit indicates a strategic pivot for Meta, emphasizing the volatility of tech giants' commitment to news. Investors should monitor Meta's evolving content strategy and consider diversifying their media platform investments to mitigate risks associated with such shifts.

Buffett's Firm Sheds 5M More HP Shares

Warren Buffett's Berkshire Hathaway has reduced its stake in HP Inc., selling nearly 5 million shares, which will bring its ownership below 10%. This move follows a trend where Berkshire has been trimming its position in the tech company, with its stake dropping from over 12% to 10.2% recently.

[📝Full article]

Key takeaway

The reduction in Berkshire's HP stake might signal a lack of confidence in the tech sector or a strategic realignment, especially given the broader tech sell-off observed. Investors should closely monitor such significant divestments and assess their tech portfolios, ensuring they are aligned with their risk tolerance and investment objectives.

European Property Funds Teeter: Real Estate Under Strain

European property funds are facing increased pressure as investors seek exits due to better returns elsewhere, leading to a potential decline in real estate valuations. This trend is particularly evident in France and Germany, with the former seeing over €5 billion worth of real estate up for sale and the latter experiencing discounted trading in funds due to stringent redemption rules.

[📝Full article]

Key takeaway

The shift away from European property funds suggests a waning confidence in the region's real estate market, especially with the European Central Bank's rate hikes making other investments more appealing. Investors should be cautious and re-evaluate their exposure to European real estate, considering diversification to mitigate potential risks associated with the sector's volatility.

Key takeaways from Aswath Damodaran's video - Sports Franchises as Trophy Assets

Here are 5 key takeaways from the video:

1. Sports and Money: The speaker emphasizes the deep connection between sports and money. While the ideal behind sports is about competition and the human spirit, the reality is that decisions in sports are often driven more by financial considerations than sporting ideals.

2. Explosive Player Contracts: There have been recent instances of players being offered massive contracts. For instance, the Saudi soccer team offered almost a billion dollars to Killian Mbappe, a French soccer superstar, for a one-year contract. Similarly, Shohei Ohtani, a Japanese baseball superstar, is expected to receive a contract in the range of 700-800 million dollars.

3. Skyrocketing Franchise Prices: Sports franchises are being sold at mind-boggling prices. The Washington Commanders, an American football team, was recently sold for more than 6 billion dollars. This trend is not isolated; franchise prices have been consistently rising over the past few years.

4. Broadcasting Revenues: Broadcasting rights for sports events are fetching enormous amounts. The NFL entered into a 10-year contract in 2021 that would bring almost 115 billion dollars in broadcasting revenues. Similarly, the Indian Premier League (IPL) signed a five-year contract for about 6 billion US dollars.

5. Difference Between Price and Value: The speaker distinguishes between the concepts of "price" and "value". While value is driven by fundamentals like cash flows, growth, and risk, price is determined by demand and supply, often influenced by mood, momentum, and behavioral forces. For instance, Forbes "prices" sports franchises based on what others are paying for similar franchises, rather than valuing them based on intrinsic worth.

[🎥Full video]

That’s all for today. Thank you for reading!