How companies raise money

Reading for India · about 4 min

What this cluster is for

Every company you own is doing 2 things with your money at all times. It is funding itself from some mixture of borrowing and ownership, and it is deciding what to do with the profit it earns.

Both decisions are made without asking you. Both are published in full, every year, in a document the company gives away free. Almost no investor opens it.

These 4 lessons are about that document and those 2 decisions. Each one ends with a calculation you run on a company you already hold, using figures that are already public, in about 5 minutes.

By the end of this cluster you will be able to:

Say, in 1 sentence, whether a company you own is financed by its owners or by its lenders
Work out whether a company can afford the debt it is carrying, and what happens to it in a bad year
See whether your ownership has been quietly reduced over the last 4 years, and by how much
Judge whether a company earns more on its capital than that capital costs — the test that separates growth from expensive growth
Measure what a company actually produced with the profits it kept instead of paying them to you
Convert a dividend yield into what you will really receive after tax

Nothing here names a stock to buy. Everything here should still work in 2036, on a company that does not exist yet.

The reading order

The 4 articles build on each other. Read them in order the first time.

The choice

Why companies need money, and the equity-versus-debt choice — there are only 2 doors. One shrinks your slice forever. The other puts somebody ahead of you in the queue.
Debt versus equity in detail: loans, bonds and shares — dilution hurts you only if the money raised earns less than the business already earns. And interest coverage tells you how many bad years a company can survive.

The decision

NPV and IRR: how companies decide if a project is worth funding — you cannot audit a company's forecasts. You can audit its record.
Dividend policy: why some companies pay you, and others never do — a dividend is an admission that the company cannot use the money better than you can. Sometimes that admission is correct.

The checklist

Every article ends in a calculation. Collected here, they are one afternoon's work with 2 or 3 annual reports open, and they are the most valuable thing in this cluster. Tick them off as you go.

Before you buy anything

Debt-to-equity: total borrowings ÷ total equity. Is this company financed by its owners or by its lenders? (1)
Interest coverage: (profit before tax + finance costs) ÷ finance costs. Below 2 means one bad year matters. (2)
Return on capital employed against the 10-year government bond yield plus about 5 points. Below it, growth is making you poorer. (3)
Convert the dividend yield into an after-tax yield at your own slab or bracket, before you compare it to anything. (4)

Once a year, on everything you hold

Share count today against 4 years ago. A rise above 15% means real dilution — can you name what it bought? (2)
Return on retained profits: (change in EPS over 5 years) ÷ (profits kept per share). Below 8% and the company should have paid you instead. (4)
The debt maturity schedule, in the notes to the accounts. How much is due inside 12 months? (2)
Capital work-in-progress as a share of capital employed. How large is the bet currently under way? (3)

When a company announces something

A fundraising: which door — new lenders, or new shareholders? Who now has a claim that did not exist yesterday? (1)
An expansion: what has this company earned on the capital it already has, and why would this project be different? (3)
A buyback: was the company buying because the shares were cheap, or because it had spare cash? (4)
A dividend increase: is it covered by cash flow, or funded by borrowing and asset sales? (4)

Habits that cost nothing

Skip banks, insurers and finance companies for every ratio in this cluster. Borrowing money is their product, and these measures will mislead you. (1, 2, 3)
Read the dividend distribution policy of anything you hold for its yield. It is short and almost nobody opens it. (4)
Use 4 or 5 years for every one of these numbers. One year tells you very little. (1, 2, 3, 4)

India and the United States, equally

Every article covers both markets at the same depth, then says where they differ and what that difference tells you. In this cluster the divergences are unusually large, and 2 of them change decisions.

Who lends. Indian companies borrow mostly from banks. American companies borrow mostly from the bond market, which is roughly 120% of American economic output against roughly 18% in India. So an Indian company's borrowing cost moves when banks change their appetite, and a healthy borrower can be refused alongside a weak one. Ask of any debt-heavy Indian company: if its banks stopped lending next quarter, what would it do?

How you are taxed on being paid. In the United States, qualified dividends and long-term capital gains are taxed at the same preferential rates, so a dividend is close to tax-neutral. In India, a dividend is taxed at your slab rate while a long-term gain on listed shares is taxed at 12.5% above an annual exemption. For an Indian investor in the top bracket, that gap is close to 3 times, and it means a company reinvesting its profits is doing something for you that the same company would not be doing for an American shareholder.

Much of the dividend investing advice reaching Indian readers was written where the tax treatment is identical. Copied without the translation, it points people towards the more heavily taxed of 2 options, every time. That is what the third section in each article is for.

A note on annual reports

Three of the 4 calculations in this cluster need an annual report. If you have never opened one, this is the whole of what you need to know.

Every listed company publishes one free on its own website, usually under Investors or Investor Relations. In India you can also find it on the NSE or BSE company page. In the United States it is the 10-K, filed with the SEC and available on the company site and on the SEC's own database.

You need 4 pages out of several hundred:

The Statement of Profit and Loss (US: income statement) — profit and the interest bill.
The Balance Sheet — equity, borrowings and cash.
The Cash Flow Statement — what actually moved, which is harder to arrange than what was reported.
The notes, for the debt maturity schedule and, in India, related party transactions.

Everything in this cluster comes from those 4 pages. The rest of the document is worth reading eventually and is not needed today.

A note on what this is not

These lessons are free and they will stay free. They are the text version of the ideas in our video course, written for anybody who cannot spend money on learning right now.

Nothing here is a recommendation. The point of every calculation in this cluster is that it works on any company, in any decade, including companies that do not exist yet. The goal is the one it has always been: fewer people in the 95%.