4 ms·

> Debt should be used to purchase an asset that will appreciate or otherwise provide an income in excess of the interest payment on the debt. Full stop. That is

by jonknee 11y ago

> Debt should be used to purchase an asset that will appreciate or otherwise provide an income in excess of the interest payment on the debt. Full stop. That is how businesses use debt and that is the only sensible strategy. Businesses use debt in all sorts of ways, they certainly don't limit it to buying assets. A common use recently is to fund share buybacks which is essentially an easy way to engineer higher earnings per share and make investors happy (but not providing any actual income). Another common use is commercial paper markets which corporations use for short term obligations (payroll!) and to smooth out cash flows, this is actually pretty similar to a credit card on a personal scale.

forgetsusername 11y ago
>Businesses use debt in all sorts of ways, they certainly don't limit it to buying assets. A common use recently is to fund share buybacks You don't think buying a stake in a successful company (in this case one that happens to be your own) is buying an asset? The mechanations are slightly different, but you're still buying shares. An effect is rising EPS (due to retired shares), but that isn't the purpose.
- jonknee 11y ago
  Not at all, it's a giveaway to executives (who get bonuses based on EPS) and long term shareholders. Some firms also borrow money to fund a dividend which is just a literal giveaway.
  - forgetsusername 11y ago
    >Not at all, it's a giveaway to executives (who get bonuses based on EPS) and long term shareholders. Putting aside the executive giveaway (because I have a hard time believing that there are executive bonuses so intertwined with EPS that the company can just burn money on buybacks to increase that bonus without any external fuss or anyone questioning why)... ...who or what else matters beyond the shareholders? Share buybacks aren't a scam. They exist as a method to return capital to shareholders and can be smart or not depending on a variety of financial circumstances. Just like every other financial decision. http://aswathdamodaran.blogspot.ca/2014/09/stock-buybacks-they-are-big-they-are.html http://aswathdamodaran.blogspot.ca/2014/09/stock-buybacks-th...
- ska 11y ago
  but that isn't the purpose Sometimes that is precisely the purpose.
surfearth 11y ago
You're correct that there are a multitude of uses for debt (e.g. working capital management). I do think the parent was on to something though - the cornerstone of the private equity/leveraged buyout industry is borrowing debt below your return on equity to amplify returns. This can be a wise strategy for individuals to cautiously replicate.
usefulcat 11y ago
I can see how a share buyback would put upward pressure on the share price, but how could it have a positive effect on earnings? Seems like it would have to have a negative effect on net earnings over the long term if the buyback was financed via a loan, due to the need to repay the loan.
- chkuendig 11y ago
  Parent was writing about "earnings per share", key word being "per share". So with fewer outstanding shares, this obviously increases.
  - usefulcat 11y ago
    Ahh, ok that makes sense, thanks.
    - jonknee 11y ago
      And EPS is one of the big metrics for share prices (the PE ratio uses it for example). It makes sense that if there are less shares they should all be worth more, but EPS is the reason why that is the case.
newjersey 11y ago
I imagine when you "buy" your supplies and don't pay for them until about ninety days after you took delivery of the supplies, that is considered debt as well? I mean if I want to ship something, Fed Ex will ask for payment up front but when Amazon.com ships something they probably don't actually send the money right away. I am still trying to grasp this concept credit terms. I must add that I have had no training in this field and have basically just skimmed through the soylent blog post http://blog.soylent.com/post/133420708272/pricing-soylent-efficiently http://blog.soylent.com/post/133420708272/pricing-soylent-ef... so in my mind, what we want to do is get the "interest-free loan" from our supplier of equal or greater duration to the credit term we give our customers. I imagine this is a double whammy because suppliers offers better terms when the going is good and become strict when the going gets bad. Now that I think about it, perhaps Apple sitting on a pile of cash isn't such a bad idea after all right? I mean if they have to go through a rough patch again, won't any credit terms they get (banks, investors, or suppliers) automatically be worse? I don't know the rules about financial stuff but my perception is that as public companies there is only so much information you can withhold (and only for so long) without breaking financial regulations (and those regulations presumably exist for a good reason).
- cperciva 11y ago
  I mean if I want to ship something, Fed Ex will ask for payment up front They might ask for payment up front, but they'll quite happily take a credit card instead. Yes, credit cards are a form of transactional debt if you pay them off each month; they allow you to enjoy your purchases for ~ 1 month before paying for them.
  - newjersey 11y ago
    I imagine the credit card payment processor pays at the end of the month? So when one accepts payment using credit card, is that an automatic 30 day credit the seller has extended to me? I didn't think about that. So essentially, the credit card issuer didn't really spend "their money" at all. Wow. The more I learn the more I realize how little I know.

by jonknee 11y ago

forgetsusername 11y ago

>Businesses use debt in all sorts of ways, they certainly don't limit it to buying assets. A common use recently is to fund share buybacks You don't think buying a stake in a successful company (in this case one that happens to be your own) is buying an asset? The mechanations are slightly different, but you're still buying shares. An effect is rising EPS (due to retired shares), but that isn't the purpose.

jonknee 11y ago
Not at all, it's a giveaway to executives (who get bonuses based on EPS) and long term shareholders. Some firms also borrow money to fund a dividend which is just a literal giveaway.
- forgetsusername 11y ago
  >Not at all, it's a giveaway to executives (who get bonuses based on EPS) and long term shareholders. Putting aside the executive giveaway (because I have a hard time believing that there are executive bonuses so intertwined with EPS that the company can just burn money on buybacks to increase that bonus without any external fuss or anyone questioning why)... ...who or what else matters beyond the shareholders? Share buybacks aren't a scam. They exist as a method to return capital to shareholders and can be smart or not depending on a variety of financial circumstances. Just like every other financial decision. http://aswathdamodaran.blogspot.ca/2014/09/stock-buybacks-they-are-big-they-are.html http://aswathdamodaran.blogspot.ca/2014/09/stock-buybacks-th...
ska 11y ago
but that isn't the purpose Sometimes that is precisely the purpose.

surfearth 11y ago

You're correct that there are a multitude of uses for debt (e.g. working capital management). I do think the parent was on to something though - the cornerstone of the private equity/leveraged buyout industry is borrowing debt below your return on equity to amplify returns. This can be a wise strategy for individuals to cautiously replicate.

usefulcat 11y ago

I can see how a share buyback would put upward pressure on the share price, but how could it have a positive effect on earnings? Seems like it would have to have a negative effect on net earnings over the long term if the buyback was financed via a loan, due to the need to repay the loan.

chkuendig 11y ago
Parent was writing about "earnings per share", key word being "per share". So with fewer outstanding shares, this obviously increases.
- usefulcat 11y ago
  Ahh, ok that makes sense, thanks.
  - jonknee 11y ago
    And EPS is one of the big metrics for share prices (the PE ratio uses it for example). It makes sense that if there are less shares they should all be worth more, but EPS is the reason why that is the case.

newjersey 11y ago

I imagine when you "buy" your supplies and don't pay for them until about ninety days after you took delivery of the supplies, that is considered debt as well? I mean if I want to ship something, Fed Ex will ask for payment up front but when Amazon.com ships something they probably don't actually send the money right away. I am still trying to grasp this concept credit terms. I must add that I have had no training in this field and have basically just skimmed through the soylent blog post http://blog.soylent.com/post/133420708272/pricing-soylent-efficiently http://blog.soylent.com/post/133420708272/pricing-soylent-ef... so in my mind, what we want to do is get the "interest-free loan" from our supplier of equal or greater duration to the credit term we give our customers. I imagine this is a double whammy because suppliers offers better terms when the going is good and become strict when the going gets bad. Now that I think about it, perhaps Apple sitting on a pile of cash isn't such a bad idea after all right? I mean if they have to go through a rough patch again, won't any credit terms they get (banks, investors, or suppliers) automatically be worse? I don't know the rules about financial stuff but my perception is that as public companies there is only so much information you can withhold (and only for so long) without breaking financial regulations (and those regulations presumably exist for a good reason).

cperciva 11y ago
I mean if I want to ship something, Fed Ex will ask for payment up front They might ask for payment up front, but they'll quite happily take a credit card instead. Yes, credit cards are a form of transactional debt if you pay them off each month; they allow you to enjoy your purchases for ~ 1 month before paying for them.
- newjersey 11y ago
  I imagine the credit card payment processor pays at the end of the month? So when one accepts payment using credit card, is that an automatic 30 day credit the seller has extended to me? I didn't think about that. So essentially, the credit card issuer didn't really spend "their money" at all. Wow. The more I learn the more I realize how little I know.