Matthew Benjamin: Hi, I’m Matt Benjamin, the Editorial Director here at The Oxford Club. Welcome to Investment U’s Getting the Market Right.
Our guest this week is Steve McDonald, the Club’s Bond Strategist. He’s here to talk about debt-to-cash and debt-to-cash-flow ratios, and why he thinks they’re some of the key numbers you should look at before you buy a bond.
Steve McDonald: Thank you, Matt.
MB: We’ve turned the tables on you this week, right?
SM: Yes, and I appreciate your doing this. It’s hard to interview yourself.
MB: Absolutely, I understand that. So, Steve, tell us, what is debt-to-cash and debt-to-cash-flow, and why should we focus on them?
SM: When you’re looking at a bond, whether it’s a corporate bond or a tax-free bond – this really doesn’t apply to Treasurys because they have unlimited cash flow; the government just prints money whenever it needs it – but with corporations and municipalities that issue bonds, the first thing you want to be certain of is this: Do they have the money to pay their bills?
And the first bill that they always pay is the interest on their debt, or the interest they owe to us as bondholders.
So the first thing that I look at is the total cash amount and the cash flow. Now, cash is very simple. How much do they have in real cash – in short-term instruments that they can get to in a hurry if they need it? I think some even include stuff as long as two- and three-month maturities.
So the cash number can vary, depending on when you look at it. But let’s say a corporation has $5 billion in debt – if it’s only got a couple hundred thousand dollars in cash, that’s a red flag.
I would like to see, out of $5 billion, at least 10% covered by cash. Maybe $500 million, somewhere in that area. And that’s a ballpark – this is all relative.
Now cash flow is a totally different issue. Cash flow is how much money comes in the front door and how much is available to be spent.
It isn’t necessarily the amount of cash, but how much of the money coming through the corporation – and it’s a simple explanation – can it use (if it has to) to pay its bills for capital expenditures, development and all those sorts of things?
Why do we focus on it? We focus on those two because there’s only one thing a bondholder has to worry about: Does a company have the ability to pay its bills?
I don’t care if it makes money. I don’t care if its earnings grow. I don’t care what its new products do. I don’t care what its CEO does. As long as it’s got the cash and the cash flow to pay that bond, we’re going to get paid. And that’s the first priority with a bond.
MB: Absolutely. So you talked about a few numbers there, but just give us a real good example here of some levels …read more
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