Understanding Debt

What is corporate debt?

When a company needs capital but doesn’t want to dilute its controlling interest by issuing equity, it borrows funds from high networth individuals, the government, or the general public.

To meet its long and short-term monetary requirements, companies issue corporate bonds or obtain loans.

Long-term loans from banks

Another way companies fulfil capital requirements is by borrowing from banks and HNIs (high net worth individuals). Most companies prefer to issue corporate bonds over obtaining a loan, as banks charge higher interest rates.

Does a company's debt matter to investors?

Before you invest in a company, you must know the company’s debt levels. Debt can be a bane or boon for a company. When used wisely, it helps companies expand and grow their operation, which increases future earning capabilities.

But high debt translates to high interest payments, which chip away at the company’s profit, bringing down its net profit, and thereby, its general reserve.

How debt impacts stock price

Low interest payments translate to companies having more profit to reinvest in their company’s expansion and growth. Hence, when companies have high debt, investors view it as a risky investment, as interest payments are high.

So, should you not invest in companies that have debt?

No, the key is to examine a company's debt level and how it utilizes it to increase future profit. It’s wise to invest in companies that aim to reduce their reliance on equity and debt.

Example: From 2014 to 2023, Tata Motors had high debt levels that kept rising, which increased interest payments and lowered profit.

But March 2023 onwards, Tata Motors significantly reduced its debt, boosting its share price. A share price that would usually trade between ₹400 to ₹550 saw a steady rise and hit a peak of ₹118.30 for the first time in 10 years! Surely other factors must have contributed to this phenomenon, but reducing debt levels is definitely one of them.