Interests and Dividends

There are those who like the periodicity and predictability of interest and dividend income. Financing philosophy varies from company to company. Some like to use debt as a leveraging tool. I personally do not like debt of any kind. They say debts are good during good economic times, because, they accentuate returns. Debts magnify losses during bad years too. However, anybody considering investing in corporate debt issues purely because of the attractive yields and expected constancy in payment, one would do well to consider whether the earnings are large enough to back the interest payments of all the debts (Bank loans, short- and long-term and any other cookie jar of loans the company has put its hand into). This information can be simply obtained by dividing the Earning before Interests and Taxes (EBIT) by total annual interests payable. A ratio of three or higher together with a good past records, say five years, of continuous interest payment is considered good investment candidate. However, there are exceptions one may make from time to time. For example, there are companies which are able to pay interests and continue to do so without ever meeting the theoretically determined margin of safety. One could invest in the debt issues of such companies and still expect the predictability offered by companies with iron-clad finance. Also, most companies try hard not to default on the interest and preferred dividend payments. They would rather hang by the skin of their teeth than default. Unlike interest, preferred dividend distribution, on the other hand, is made after taxes have been paid. Therefore, when calculating adequacy of dividend coverage, it is grossed up to its pre-tax value. Tax rate can be calculated from the company income statement. The grossed up dividend is then added to total interests payable. This value is then used to divide EBIT. The ratios so obtained from past five or more years can be plotted and see if the trend is improving or declining. Records of interest and dividend coverage can be made more meaningful when examined in the light of company fundamentals. If the company fundamentals are expected to remain comparable to or improve upon those of interest and dividend paying years, then one can assume with high degree of confidence that interest and dividend payment would continue.

Some feel that life is a terminal disease. Do you disagree?