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The Equitymaster Research Digest

Why We Deliberately Avoided Public Sector Banks Since 2013
Feb 23, 2016

What would you buy if you had too much money at your disposal? Mansions, private jets, yachts, new businesses?

The problem is that excess funds with no meaningful objective can disorient us. So we need to be careful in assessing how we spend. Whether it is wealthy individuals, companies with excess cash on books, or banks with more money than they can lend, the end use of surplus cash can get tricky.

Precisely for this reason, we are cautious about companies with billions of rupees in cash on their books. If the company has firm plans to repay debt, fine. A track record of buying unprofitable businesses cheap and turning them around is also good. In such cases, we are almost certain that the cash will be put to a good use at some point. And companies constantly in need of capex, rather than borrow, can use surplus cash to fund their projects.

But if none of that applies, the company should be paying out cash to shareholders. In other words, the surplus cash should translate to higher dividend payouts. Cash-rich companies that prefer to park millions in liquid funds are not exactly our favourites. We are even more skeptical of businesses that delay paying off debt despite having the resources to do so.

As Rahul wrote in a recent edition of Research Digest, cash on the balance sheet is to us the proverbial black box: One can never really be sure what the management intends to do with it. We've seen a lot of managements get carried away and pursue projects that do not yield great returns.

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