At the end of the year he paid back what he borrowed.
Saul, what is he using to pay this back with? He used the debt to pay employees, buy raw materials, rent space, etc. That money is out the door. Where is he getting the cash to pay back the $10M?
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--------------------------------------------------------------------------------------------------------------------------------------------------------------------- by the way, as presented my conclusions are obviously correct, so don’t waste time trying to disprove them…but I made an unwarranted assumption you haven’t noticed yet. See if you can find it.--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
At the end of the year he paid back what he borrowed.
Saul, what is he using to pay this back with? He used the debt to pay employees, buy raw materials, rent space, etc. That money is out the door. Where is he getting the cash to pay back the $10M?
Ears, You solved the riddle! That was the unwarranted assumption! 
If you accept that he paid back the money at the end of the year, he did great. But your idiot cousin didn’t just invest the cash to make 1% above the interest rate he was paying. He was busy spending the money on growing the business. And not doing very well at it. You are absolutely correct.
Saul
Ears, You solved the riddle! That was the unwarranted assumption! If you accept that he paid back the money at the end of the year, he did great. But your idiot cousin didn’t just invest the cash to make 1% above the interest rate he was paying. He was busy spending the money on growing the business. And not doing very well at it. You are absolutely correct.
Hi Saul,
I appreciate a good riddle as much as the next person. The one I asked my grandkids last week was “What do you put into a box that makes it lighter?”.
That aside, do you still think my point was about debt rather than the relationship between growth rates, investment and rates of return? If so, what can I do to make it clearer?
Thanks,
Ears
I appreciate a good riddle as much as the next person. The one I asked my grandkids last week was “What do you put into a box that makes it lighter?”.
Lighter fluid?
The Captain
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Perhaps a lightbulb at the end of an extension cord?
Hi Ears, I believe I understand what you are saying now. It’s basically that if you get additional capital by borrowing instead of by issuing more shares in exchange for the capital, any additional revenue (and earnings) you get, from the additional capital provided by the loan, is accretive. But you are saddled with the additional debt, and the interest on it. And unless you invest that money well, to provide a goodly amount of earnings and cash flow, you can’t go back to that well often because of accumulating debt and interest owed.
So, in a way we are both right. While the issue you are presenting is the inadequate earnings producing deceptively high growth in earnings, it does come back to accumulating debt as the factor that does you in.
I’d add that raising capital by a secondary offering has its problems too, in that the stock is diluted and earnings have to go up by enough to cover the diluted number of shares. But in thinking about it, although I don’t like my stock diluted, that method is more transparent to the stockholder, as you can see rapidly enough whether EPS bounces back to previous levels and beyond, and at what speed. At leinadequate earnings producing deceptively high growth in earnings, it does come back to accumulating debt as the factor that does you in.
Best,
Saul
Great discussion! Ears, you touched on this briefly earlier, but I wonder if you could say more about how this applies to companies like APPL and COST that are borrowing money to pay dividends (since they have big piles of cash overseas and would have to pay high taxes to repatriate the cash)? That doesn’t seem like a good thing to me in terms of future earnings, but it sounds like you’ve accepted it as possibly a good practice. I still struggle with it.
you touched on this briefly earlier, but I wonder if you could say more about how this applies to companies like APPL and COST that are borrowing money to pay dividends (since they have big piles of cash overseas and would have to pay high taxes to repatriate the cash)? That doesn’t seem like a good thing to me in terms of future earnings, but it sounds like you’ve accepted it as possibly a good practice. I still struggle with it.
Hi Carpian,
There are probably others on this board who can do a much better job in answering your questions about Apple or Costco because I don’t follow either company. But here goes, fwiw…
I briefly looked at the most recent 10-K’s for both. Whenever I want to find out about debt I look at the Notes to the financial statements in the 10-K. Debt is usually discussed in one of the earlier Notes. For Apple it’s Note 6 and for Costco it’s Note 4. These notes usually tell you the maturities of the debt and sometimes will tell you the intended uses for the cash.
But for Apple I cheated…this article seems to explain what’s going on, and also supports your theory about the cash overseas, and it is consistent with what’s said in the 10-K, so I defer to the article:
http://dealbook.nytimes.com/2013/04/30/apple-raises-17-billi…
For Costco, it looks to me more like a timing issue. They paid a special, huge dividend at the end of 2012 and at the same time borrowed about the same amount as the dividend in relatively short duration loans with very low interest rates. The loans are evenly spread over time – they are due in 3, 5, and 7 years. Even with the ton of cash Costco generates each year, it seems to make sense that they would finance it over the 3-7 year period of the loans because they probably couldn’t pay that huge lump sum out of cash flow in 2012. They produce so much cash each year that coverage is not an issue for them and also not an issue for paying back the loans.
Both companies are not only paying dividends but also repurchasing shares as a way of returning money to shareholders. Borrowing is used for both. They get the tax benefit, they get super low rates, and the tremendous cash flows of both companies well supports the borrowing. Both of these are great businesses with very high rates of return. The article cited above says Apple got Moody’s second highest rating for its debt because of concerns about “shifting consumer sentiment” and “evolving technology”. But Moody’s second highest rating is not chopped liver! The article was also interesting when it contrasted Apple’s borrowing in its early days.
Again, I’m pretty ignorant of both, so fwiw.
Thanks for asking,
Ears
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The bulk of this thread is exactly the reason I tend to just roll over with financial analysis.
I guess it’s all very meaty and substantive, but as far as I’m concerned it’s just all in the weeds (and I don’t mean weed as in ganja, I mean weeds as in perplexing and not very meaningful details).
Might it be summed up by saying if a companies debt is growing faster than earnings, proceed with a great deal of caution - or maybe just walk away?
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Might it be summed up by saying if a companies debt is growing faster than earnings, proceed with a great deal of caution - or maybe just walk away?
From the original post…
BOTTOM LINE: Growth rates, P/E, and PEG are attributes of value, not determinants of value.
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