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How to avoid the dangers of debt

As the UK emerges from lockdown, share prices are beginning to recover. But the burden of a big debt pile means that some companies may have rerated too strongly.
How to avoid the dangers of debt
  • Weak balance sheets should be a major red flag for stockpickers
  • SSP and WH Smith provide a lesson in overoptimistic recoveries

As a general (if not golden) rule, investors should tread carefully around businesses classed as having “a weak balance sheet”. In the stock market rebound from the initial Covid shock in Q1 2020, this rule may have been overlooked and the share prices of many financially weaker companies have climbed steeply, some perhaps too steeply. 

Many share prices are back to, or even well above, pre-Covid levels despite radical changes for many industries and individual companies. This is hard to square when a business model is unchanged, with trading likely to resume only at prior levels (at best) and where the financial position has been significantly weakened. This suggests there could be overstating of potential and understating of risk.    

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