Both investors and traders can benefit from this characteristic

Publish date: 24th August, 2018

Samuel Johnson, who has been widely regarded as the greatest man of letters in the English language, wrote that “Without frugality none can be rich and with it very few would be poor”.

In the year 2018, Eid al Adha - commonly known as Bakra Eid in the Indian sub-continent, was observed by Muslims all over the world between 21st and 22nd August. This almost coincides with the culmination of ‘Shravan’ month, which has been observed by several Hindus.

Although these practices are different, they both emphasize on an underlying spirit--sacrifice. For Muslims, it is about sacrificing something that they reared with immense love and care. Meat-eating Hindus avoid partaking liquor and non-vegetarian food and thus, sacrifice the desire to consume flesh. Even those who are vegetarians avoid other types of food.

By fasting and engaging in charitable activities, one seeks to maintain frugality during this time. It is believed that the Almighty answers the prayers of those who kept this penance. There are said to be scientific benefits too

As in the religious word, frugality also benefits those who practice it in the material world. Frugal companies, which are well set on the path of growth, are often favored by investors and traders.

Let us look at the reasons why such companies can be considered:

Companies that cut costs:

One of the reasons why Amazon has been able to endear itself to shareholders in the US is because it is always looking to reduce costs. RJ Hottovy, the director of equity research at Morningstar had remarked that “Cost-cutting is the cornerstone of Amazon”. It helped investors and lenders kept faith in the company even when they were continuously reporting losses. However, reduction in expenses should be matched by increase in revenue and profits.

Efficient companies:

Companies which are operationally sound are often able to offer higher margins. This is because they can either command better prices from customers thanks to differentiated offerings or reduce costs by optimizing plant, machinery and other resources. They may also be able to squeeze the best possible prices from vendors due to higher bargaining power. Looking at BSE 500 stocks between December 2016 and 2017, the companies that consistently increased their net profit margin quarter on quarter were able to offer almost 5 times the return delivered by the BSE 500 index, as per an Economic Times report.

Companies that avoid inorganic growth and rather focus on growth through strong cash flows:

Pursuing inorganic growth often pushes companies to gather debt in their books. Such companies may most likely raise debt to finance acquisitions. According to research conducted by a leading business daily, 57% of market cap of listed non-financial companies belonged to debt-free firms even though they accounted for just 25.6% of the sample companies’ sales. The market assigns a premium to debt-free companies. This is evident from the fact that a typical debt-free company is valued 28 times its net profit, whereas a company possessing a debt-to-equity ratio of up to 0.25 times is valued at 18.1 times its net profit. Whenever market cycle changes, debt-free companies are able to offer better return to share holders as they don’t need to funnel some of their earnings to paying off debts.

Trading in debt free companies also ensures that downside is low:

During the first quarter of 2018 when markets fell, investors punished companies that were highly leveraged. Their stock prices declined drastically ranging from above 10% to more than 20% in some cases. For traders, this becomes a difficult scenario as one cannot predict the downside with high debt companies. If a trader tries to average it, there is always the danger of catching a falling knife. With debt-free companies, the chances are that a downside is low as there could be confidence that the prices could go up once the market turns.

A devotee believes that by practicing an ascetic life style, even though for a short duration, he may receive divine blessings. Similarly, in the world of stock market, one would do well to remember that if an organization sacrifices extravagance at the altar of frugality the rewards for shareholders could be substantial.

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