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Using debt to generate income.

Friday, May 30, 2014

I went for an evening walk earlier and during that one hour, I thought about many things. Well, that isn't unusual for me. I think too much, many tell me. One of the things I thought about was the issue of debt used in investments.

For example, how risky is an investment for which the debt is meant to fund? People always wonder how to measure risk properly and there are people who are paid to study and manage risks. I am not a professional in this area and I only have a very simple understanding of the matter.


One consideration which is probably universal is that of time. Time? Yup, time.

Basically, the longer a business investment makes me wait before I am rewarded, the riskier it is. The prospective returns will have to be much higher to compensate for this risk. So, if debt is used to fund an investment with a long gestation period, I would consider it risky and would require a much higher return to be interested.

If an investment would generate income very soon, then, the use of debt in such an instance could be considered to be less risky. In such an instance, I might be quite happy with a lower return on investment.

Another example of a question to ask is whether the benefits generated from the investment are sustainable. If the benefits generated from the investment are sustainable, then, the use of debt to magnify the benefits would make more sense.

Debt can be good or bad. It is too easy to say that we should avoid highly leveraged investments but we really should examine each leveraged entity closely and not generalise.

Related posts:
1. Don't think and grow rich.
2. Secret to avoiding financial ruin.
3. Get on top of your finances.
4. Snowballing towards bankruptcy.
5. Total Debt Servicing Ratio (TDSR).

15 comments:

Solace said...

Your Font Size today is pro elderly.

haha, i like that :) Must be getting old Lol

sparks said...

Dear AK,

I am new to equity. Trying to learn to analyse companies. As you blog much abt yongnam, I have the interest to buy the stock and thus i pick it up to analyse.
I found out that there is no PE ratio, the debt to equity is near 60%, beta is 1.5...its EPS average 5 yrs is -31%. The company does have continuous business and projects and the price is really attractive to buy. However,I would like to clear some of my doubts regarding the facts that i found.Please advise.
May i know whether you think it is suitable for long position long term. If so, could you pls enlighten me?
Besides, if you have time, could you please share the detailed way to calculate a stock's intrinsic value?
Thank you and thanks for blogging :)

Richard Ng said...

As far as share investment is concern, I am of the view that it is no-no to use debt to fund the investment

AK71 said...

Hi Solace,

I have to thank a reader who suggested that my blog's font size is a bit small. So, giving the larger font size a try. Not bad. I like it too!

I am wearing reading glasses these days when I read or do computer work for prolonged periods of time. Less tiring for my eyes. -.-"

AK71 said...

Hi sparks,

Yongnam made losses in recent months. So, I guess that is why you could not get a PE ratio since there was no earnings.

What would you consider to be "long term"? Yongnam is in a cyclical industry, construction. So, it has ups and downs. If we believe that prospects are looking up, then, we should buy and hold. If prospects are dim, then, obviously, we should think of selling.

As for a stock's intrinsic value, there are many approaches to this. A reader on FB shared his detailed method in calculating Yongnam's intrinsic value. See comment number 2:

http://singaporeanstocksinvestor.blogspot.sg/2014/02/yongnam-dps-of-06c.html#comments

Personally, I try to keep things simple because my brain isn't so advanced. ;p

See:
http://singaporeanstocksinvestor.blogspot.sg/2013/08/when-to-buy-hold-or-sell-part-1.html

Valuation is a subjective exercise. :)

AK71 said...

Hi Richard,

Yes, I agree. I use my own money for investments and sleep better at night. :)

AK71 said...

Regarding a leveraged investment property:

Desmond Yee: I use debt to leverage wor. Read too much of rich dad poor dad. lol

AK: Your leveraged asset is producing regular income for you.

Desmond Yee: That is the plan. Now hope to find new tenant soon!

AK: Prices and rentals are all falling... As long as the net yield is 3.5% or higher, I believe that there is still some margin of safety. Also, keep gearing level at 50% or lower and have the ability to pay down the loan completely if the situation calls for it.

Desmond Yee: how you calculate net yield? your calculation might be different from mine lol

AK: Net yield is based on zero leverage. Gross rental income minus all expenses and taxes = Net rental income. Divide this by the market price of the property = net yield.

Desmond Yee: i always wonder if I should push the gear down to 50% leh. Its like a lot of my own cash in the property. The plan is to let the tenants pay the loan off for me.

AK: It is really up to the individual. This is just me. I am a bit conservative when it comes to debt. However, it makes sense if we have money getting paid 0.05% per annum in a savings account which we have not earmarked any purpose for. A lower amount of debt gives me a peace of mind which is priceless and, of course, I pay less in interest on that housing loan too.

Passive Income Builder said...

Wah copy paste from fb? You owe him a teh o!

yeh said...

My friend has one hdb and one condo.
Currently staying in condo and rent out his hdb.
Still servicing debt close to 900k debt.
And thinking to buy another property to flip.

Wonder whether he is doing right thing.

temperament said...

Who is the biggest DEBTOR IN THE WORLD now? BRIC OR EURO OR US? But can individual print money?
i have used minimum debt in all my endeavours-sleep well at night-No regrets- doing not too bad.
But if i am running an active business, i am just too happy if a bank or someone willing to be my financier. Aka using OPM.

AK71 said...

Hi PIB,

Most of my readers don't follow me on FB. This is an efficient way of sharing what I think are interesting happenings on my FB wall. :)

Obviously, you follow me on FB. ;)

AK71 said...

Hi yeh,

It will depend on how much that $900k worth of debt is in terms of leverage. It could be that his properties are worth $2.7 million. Then, $900k of debt is only 33% gearing. Quite comfortable. ;)

Having said that even if his personal gearing level is 70%, everyone's risk appetite is different. :)

AK71 said...

Hi temperament,

Debt can be a good thing but too much of a good thing can be dangerous. ;p

People are getting drunk on cheap debt and that, I believe, is dangerous. -.-"

moneytree said...

How do I get a cheap debt?

AK71 said...

Hi moneytree,

For example, a housing loan now could attract an interest rate of only 1.3% per annum. That is pretty cheap. ;)

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