Investors who view continuing low interest rates as an all-clear sign for heavily leveraged companies may want to look at the chart below before breaking out the champagne. It shows that on a per-share basis, interest costs—driven by voracious borrowing—have hit a level not seen since the financial crisis a decade ago.
So why does this matter? Higher debt-servicing costs could translate to pressure on profit margins as businesses need to siphon from top line revenue to satisfy creditors.
Margin compression is a concern for investors against any economic backdrop much less the late stages of a decade-long expansion. If the economy slows and consumers and corporations curb their spending, the negative effects of interest costs will be amplified as fixed debt payments will eat into ever-smaller revenue streams.
While the temptation for management to borrow on the cheap in an effort to expand and goose sales can be strong, history hasn’t been forgiving of that approach. As a result, we think in the quarters ahead businesses that have been running with clean balance sheets will once again gain favor with investors.
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Leverage is the amount of debt used to finance a firm's assets. A firm with significantly more debt than equity is considered to be highly leveraged. S&P 500 Index is an index of 500 U.S. stocks chosen for market size, liquidity and industry group representation and is a widely used U.S. equity benchmark. All indices are unmanaged. It is not possible to invest directly in an index.
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