Debt
Why does debt matter when buying shares?
Learn why experienced investors always pay attention to borrowing before buying a company.
Two companies can earn the same profit, sell the same products and trade on the same valuation. One is a comfortable long-term hold. The other could be wiped out by a single bad year.
The difference is usually hidden in the one place beginners skip and professionals read first: the debt.
Get debt right and a good business can compound your money for decades. Get it wrong and even a famous name can hand you a permanent loss. This guide shows how to read debt the way sensible long-term investors do, and how the DeepSleepInvest Debt card turns it into one quick, plain-English check.
Why we look at debt at all
A share is a slice of a real business. When you buy it, you also take on a share of everything that business owes.
Borrowing is not automatically bad. Used well it builds factories, funds expansion and buys profitable rivals. Used badly it drains cash, removes choices and slowly hands control to the lenders.
The job is to tell the two apart before you invest, not after.
Three of the investors DeepSleepInvest is built around learned this and never forgot it:
- Warren Buffett prizes businesses that can survive any economy, which usually means little or no debt.
- Peter Lynch chased growth, but warned that a balance sheet full of borrowing can sink even a great story.
- Robbie Burns simply prefers shares that let him sleep at night, and heavy debt is the enemy of sleep.
How the Debt card works
DeepSleepInvest does not drown you in ratios. The Debt card asks one common-sense question:
If this company used all of its yearly profit to pay down what it owes, how many years would that take?
That is net debt (borrowings minus cash) divided by annual pre-tax profit. It is the same "years of profit" thinking behind the valuation check, pointed at the balance sheet instead of the share price.
| Debt card | Roughly what it means | How to read it |
|---|---|---|
| Net cash | More cash than debt | A real strength. No lender to worry about. |
| Light | Under 1 year of profit | Comfortable, easy to handle in a downturn. |
| Manageable | 1 to 3 years of profit | Normal for many solid companies. Watch the trend. |
| Heavy | More than 3 years of profit | Higher risk. Everything has to keep going right. |
A green card is not a guarantee and a red card is not an instant no. Context matters. But the further down that table you go, the more things have to go perfectly for shareholders to win.
Company Alpha Pre-tax profit: GBP 80m Net debt: GBP 50m Debt card: Light (under 1 year of profit) A slightly worse year is uncomfortable, not dangerous.
Company Beta Pre-tax profit: GBP 80m Net debt: GBP 1.2bn Debt card: Heavy (about 15 years of profit) The same bad year, and the bank starts running the conversation.
Same profit. Same industry. A completely different way to sleep at night.
Good debt versus bad debt
Experienced investors do not ask "is there debt?" They ask "what is the debt actually doing?"
| Good debt | Bad debt |
|---|---|
| Builds assets that earn more than they cost | Pays everyday bills the business cannot cover |
| Funds expansion with a clear payback | Plugs losses and buys time |
| Falls over time as it does its job | Climbs year after year |
| Comfortably covered by profit and cash | Swallows a growing share of profit |
The first column can make shareholders richer. The second slowly transfers the company from its owners to its lenders.
Four red flags worth your attention
Debt that rises every single year. Borrowing can be sensible, but if it climbs much faster than profit for years, something is being papered over.
Interest eating the profits. A company does not only repay debt, it pays interest to hold it. When interest swallows a large slice of operating profit, shareholders get the leftovers.
Borrowing to pay the dividend. One of the loudest warning signs. A dividend funded by loans rather than cash is living on borrowed time, literally.
Debt that only works at low rates. Borrowing that looked cheap at 2% can turn painful at 7%. Rates change, and the business has to survive all of them.
Four green flags that help you sleep
Falling debt. Quietly one of the best signs in investing. It usually means honest profits and disciplined management.
More cash than debt. Net-cash companies get to play offence in a downturn while rivals are begging the bank for mercy.
Strong free cash flow. Profit is an opinion shaped by accounting rules. Cash is a fact. Businesses that throw off real cash rarely have debt problems.
Interest covered many times over. If profit covers the interest bill several times, a rough patch is survivable.
Cash is king
Here is the habit that separates careful investors from hopeful ones: they check cash before they celebrate profit.
Profit can be massaged with accounting choices. Cash is far harder to fake. A business generating plenty of free cash flow can repay debt, fund growth and pay dividends out of its own pocket. A business reporting healthy profits but little cash, while borrowing more each year, is telling you something the headline number is hiding.
Debt in a downturn
Debt feels harmless when business is booming. The test comes when it is not.
Picture sales falling 30% in a recession.
A low-debt company trims costs, rides it out, and may even snap up weaker competitors at bargain prices. A heavily indebted company faces the same fall in sales while the interest bill carries on regardless. Banks get nervous. The company raises money by issuing new shares, diluting the owners who stayed. In the worst cases it does not make it out at all.
This is why debt is the quiet decider. It rarely matters in the good years and almost always matters in the bad ones.
Your 60-second debt check
Before you buy any share, run through this:
- What does the Debt card say: net cash, light, manageable or heavy?
- Is debt rising or falling over the last few years?
- Does profit cover the interest comfortably, several times over?
- Is the business generating real free cash flow?
- Is the dividend paid from cash, or topped up with borrowing?
- Could this company survive a bad year without a rescue?
Six questions, one minute of your time. They will steer you away from a surprising number of disasters.
The bottom line
Debt rewards investors who understand it and punishes those who ignore it. The best businesses in the world borrow money and do it brilliantly. The worst use it to delay an ending that arrives anyway.
So before the exciting profit figures pull you in, look one line lower on the balance sheet and ask the question Burns, Lynch and Buffett never skip:
If times got hard, could this company comfortably pay what it owes?
If the answer is a confident yes, you can probably sleep. If it is a maybe, keep digging. And if it is a no, no share price is cheap enough to make heavy debt safe.
Run a Sleep Score on a company you are weighing up, and check its Debt card first. Your future self will thank you.