Leverage – a double-edged sword?

Debt in the hands of a wise person can do wonders!

Our tendency is to focus on the company’s low debt, forming the basis for decisions. Zero debt is considered a boon. But, is debt really that bad?

Here, I take a couple of perspectives

Corporate: Let’s say, you are the only investor in a company that needs $10 in capital. The next year, the company clocks $20 in profits, which you pocket, being the sole investor. Return: 100%

Compare this to a situation where the company finances $5 through debt, and you invest the remaining $5. The company generates $20 in profits, and after paying off the $5 principal, you get the remaining $15. Return: 200%

This phenomenon, known as leverage-led return amplification, is a great tool to improve returns, used right

Country: A high Debt/GDP does not imply an impending collapse. Japan, at a Debt/GDP of ~235%, is safer than Pakistan, sitting at a meager 75%

This is majorly due to
1. Its strong reserve base
2. >90% of its debt is financed by domestic investors, in contrast with Pakistan, which relies more on external financing. Remember, borrowing from your father is safer than borrowing from a bank

Having fewer obligations is unshackling, but it is vital to understand the entire context