Finance Gyan by Dr. Anil Lamba | Are you sure highly leveraged companies are riskier?

How do you identify safe investments?

Hi this is anil lamba with another round of finance gyan you know i have often eulogized about the advantages of debt over equity folks i am not advocating rash debt i am dead against using borrowed money for unproductive purposes but if you can use debt for productive purposes where you can generate a return which is substantially greater than the cost of debt

And where the money invested can bring a cash inflow before the outflow has to happen on account of repayment of debt that kind of borrowing i would definitely recommend and then when i illustrate with the help of an example that if there are two companies identical to each other in every respect except the method of funding one company raises money principally

By way of equity the other one uses a larger component of debt the company which has borrowed more its earnings per share its return on equity is substantially greater than the other one when i illustrate this many people in the audience after an initial sense of disbelief then they point out but you know this company is riskier i completely concede the point the

Element of risk is substantially higher in the company that borrows more if there’s an established correlation between risk and return high risk high return but then my counter question to them is are you sure and they say what do you mean i said are you sure that is risky i’m already conceding the point but my question still is are you sure what do i mean by

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That folks had you asked the finest brains in the world in the month of october 2001 what do you think of enron had you asked who the best brains in the world by this i mean the meryl lynches and the goldman sachs of the world when october 2001 what do you think of enron you know without exception each one of these companies was saying number one there hasn’t

Been a company like enron in the entire century number two without exception they were putting a buy recommendation against enron in october 2001. by december 2001 the company didn’t exist anymore when the finest brains in the world three months before the demise so one of the most celebrated companies of the century could not anticipate this company won’t be

Around anymore are you and i qualified to judge risk are we qualified to judge safety so when these people point out this company is riskier my question is are you sure folks what i’m trying to tell you is very often we invest our money on grounds of safety when we do not understand anything about safety except its spelling when you choose investments on grounds

Of safety you have not guaranteed safety for yourselves but what you have guaranteed for yourselves is mediocre returns and therefore my point is maybe a certain portion of your money you must consciously put in risky avengers perhaps with this small portion of your investment the return that you may generate may be greater than what the rest of your portfolio

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Might generate for you food for thought for today you

Transcribed from video
Finance Gyan by Dr. Anil Lamba | Are you sure highly leveraged companies are riskier? By Anil Lamba