Just like the credit-card holder making liberal use of a 0% interest promotion, some firms have gorged on cheap liquidity over the last decade, taking advantage as governments used a low-interest rate environment to pull their economies out of recession.
That this has helped inflate equities, as well as central bank balance sheets, has been conveniently ignored by markets – or at least set to one side – as the stockmarket powered to a record bull run. Now though, time has been called – rates have been gradually rising (albeit at a moderate tempo) and quantitative easing unwound. Those highly indebted companies no longer look quite the prospect they once were. The 0% interest deal has expired.
Until recently, living with higher interest rates was something of a distant memory (and for some it is a totally new experience). But it is exactly this kind of environment that shows why in-depth credit analysis of the companies in investors’ portfolios is so important. As income investors, having a high conviction in a firm’s ability to deliver real dividend growth is paramount.
This means assessing if the company has an appropriate capital structure for the nature of its business; ensuring it has sufficient liquidity to cover any unseen events and questioning whether financial obligations pose a threat to cash flow and dividend sustainability – essentially can it ensure that there’s no risk of the dividend being cut.
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