Debtor

A debtor is any person, company, or government that owes money to another party. The party they owe money to is known as a creditor. Think of it as a financial handshake: one side (the debtor) receives funds or goods now with a promise to pay later, while the other side (the creditor) provides them, expecting to be paid back, usually with interest. For an everyday investor, understanding who the debtors are and how they manage their obligations is crucial. When you buy a company's stock, you become a part-owner. If that company is a debtor—and most are—its ability to handle its debts directly impacts its profitability and, ultimately, the value of your investment. A company that borrows wisely to grow can be a goldmine, but one that drowns in debt can sink your capital along with it. The story of a company's debt is written on its balance sheet under the heading of liabilities, and learning to read that story is a fundamental skill for any value investor.

This is the oldest story in finance. At its heart, the relationship is a simple promise. If your friend owes you $5 for a coffee, they are the debtor, and you are the creditor. Scale this up, and you have the entire global financial system.

• Companies as Debtors: A business might take out a loan from a bank to build a new factory. The company is the debtor, the bank is the creditor.
• Governments as Debtors: When a government issues bonds to fund public projects, it becomes a debtor to the individuals and institutions that buy those bonds.
• Individuals as Debtors: Anyone with a mortgage, student loan, or credit card balance is a debtor.

In each case, the debtor has a legal obligation to repay the principal (the original amount borrowed) plus any agreed-upon interest.

Warren Buffett once said, “You can't make a good deal with a bad person.” The same logic applies to debtors. As an investor, you're essentially making a deal with a company. You need to know if it's a responsible borrower or a reckless one. A company being a debtor isn't a red flag on its own; in fact, smart borrowing, or leverage, can supercharge growth. The key is to distinguish between healthy and toxic debt.

Before investing, you must play detective and investigate the company's debt situation. The clues are all there in its financial statements.

1. Check the Balance Sheet: Look at the liabilities section. How much long-term debt versus short-term debt does it have? A sudden spike in debt without a clear reason (like a major factory expansion) warrants suspicion.
2. Use Key Ratios: Don't just look at the raw number. Context is everything. Two powerful tools are:
   • Debt-to-Equity Ratio: This compares a company's total debt to its total shareholders' equity. A high ratio (say, over 2.0, depending on the industry) can indicate that the company is relying heavily on borrowing, which increases risk.
   • Interest Coverage Ratio: This measures a company's ability to pay the interest on its outstanding debt. It's calculated by dividing earnings before interest and taxes (EBIT) by the interest expense. A higher ratio is better; a ratio below 1.5 is a serious warning sign that the company may struggle to meet its interest payments.

Not all debtors are created equal. As a value investor, your job is to sort them into three categories.

• The Good Debtor: This company uses debt wisely. It borrows money to invest in projects that generate a higher return on invested capital (ROIC) than the cost of the debt. This creates value for shareholders. Think of a company borrowing at 4% interest to build a facility that returns 15% annually. That's smart business.
• The Bad Debtor: This company is careless with debt. It might borrow too much, use it for unproductive purposes like overpaying for acquisitions, or fund massive share buybacks when its stock price is already high. While not on the brink of collapse, its debt drags down performance and puts shareholder capital at unnecessary risk.
• The Ugly Debtor: This company is drowning in debt. It struggles to make interest payments, and its business operations aren't generating enough cash to dig itself out. The risk of bankruptcy is real. For an equity investor, this is a “run, don't walk” situation, as shareholders are often the last to get paid (if at all) when a company goes under.

The same principles that apply to companies apply to your personal finances. A mortgage to buy a home can be “good debt” if the terms are manageable and the asset appreciates over time. However, racking up high-interest credit card debt to pay for luxury goods is classic “bad debt.” Understanding the role of a debtor from both a corporate and personal perspective makes you a sharper, more insightful investor. After all, the best investors understand the fundamentals of finance from the ground up.