In this article, we will take a detailed look at the 7 best debt free stocks to buy.
Debt has always been the fuel driving many companies in the equity markets. Access to cheap capital when interest rates were at all-time lows of 0.25% saw most companies in the S&P 500 bolster their balance sheet to finance various operations, including research and development and recurrent expenditure.
However, during the Federal Reserve’s meeting on July 30-31, 2024, interest rates were kept unchanged at 5.25% – 5.50%. Officials noted that inflation is nearing its target, potentially allowing for future rate cuts. “The Committee judges that the risks to achieving its employment and inflation goals continue to move into better balance,” the Federal Open Market Committee stated. Chair Jerome Powell mentioned that a rate cut could be possible in September if inflation continues to ease.
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To combat inflation, the rate was raised 11 times between March 2022 and July 2023. Amy Hubble, principal investment advisor with Radix Financial, noted, “If they cut 0.25% at a time, that’s 12 cuts over several years. So this isn’t something that’s going to happen quickly.”
The interest rates companies pay for business loans in the US vary widely based on factors like the type of loan, the lender, and the company’s creditworthiness. As of 2024, average interest rates for small business term loans range from 7.85% for fixed-rate loans to 8.79% for variable-rate loans. Online business loans can have rates from 9% to 75%, while SBA loans range from 11.50% to 16.50%. Rates can be significantly higher for businesses with poor credit.
Nevertheless, one thing that became clear after the 2008 financial crisis is that large debt loads can weigh on a company, leading to severe implications. Amid the high interest rate environment, with the US Federal Reserve hiking interest rates last year to between 5.25% and 5.50% to try and tame inflation, companies failing to meet their debt obligation increased to 153 from 85 the previous year.
Big businesses could be in trouble as the Federal Reserve reports a staggering $13.7 trillion in debt in corporate America. S&P indicates that the amount of debt companies hold has increased by 18.3% since 2020, largely due to firms taking advantage of the Federal Reserve’s move to reduce interest rates at the beginning of the pandemic.
While most people might argue that companies with zero debt are not optimizing their capital structures for growth, that’s only sometimes the case. The best debt-free stocks to buy are companies with solid balance sheets owing to their strong free cash flow generation capabilities. It also affirms the resiliency of the company’s core business to generate significant cash flow, therefore fending off the need to take up debt.
However, taking on debt is only acceptable if the business generates profits and adopts strict protocols to prevent defaulting on payments. If major corporations default on their obligations, it might lead to bankruptcy.
In the US, concerns about impending recession and an uptick in the benchmark rate resulting in higher interest payments have compelled businesses to reduce their debt levels significantly. Consequently, some companies have stood their ground, operating within their means by relying on their free cash flow instead of taking up debt.
In this case, some companies have a history of operating with low or no debt. Instead of taking up debt, they hold cash and short-term highly liquid assets to make acquisitions and finance day-to-day operations.
Therefore, the best debt-free stocks to buy belong to firms that have successfully met their financial responsibilities, making them intriguing investments for individuals seeking stability. A debt-free position indicates lower financial risk and increased financial flexibility for the organization.
The debt-to-equity ratio is a popular financial metric used to measure a company’s financial leverage. It is arrived at by dividing total liabilities by shareholders’ equity. Companies with high debt-to-equity ratios relative to the industry’s average imply they rely more on debt to finance their operations, which can be risky.
Generally, the best debt-to-equity ratio of any company looking to manage its debt load is 1 to 1.5. However, the appropriate ratio depends on various factors, including the company’s growth stage and industry sector.
In addition to the debt-to-equity ratio, it is essential to evaluate the enterprise value when analyzing the best debt-free stocks to buy. Enterprise value is arrived at by considering both the current share price (market capitalization) and the cost to pay off debt (net debt or debt minus cash)
Companies in a solid financial position tend to have a much lower enterprise value than market cap, i.e. more net cash.
Our Methodology
We meticulously reviewed the top 100 stocks from the Yahoo screener, selecting those with zero or very little debt. We compared their enterprise value (EV) to their market capitalization. We then ranked the best debt-free stocks in ascending order of their potential upside, as of August 16.
At Insider Monkey, we are obsessed with the stocks that hedge funds pile into. The reason is simple: our research has shown that we can outperform the market by imitating the top stock picks of the best hedge funds. Our quarterly newsletter’s strategy selects 14 small-cap and large-cap stocks every quarter and has returned 275% since May 2014, beating its benchmark by 150 percentage points (see more details here).
7 Best Debt Free Stocks To Buy
7. Silicon Motion Technology Corporation (NASDAQ:SIMO)
Market Cap as of 16/08/2024: $2.14 Billion
Enterprise Value: $1.93 Billion
Upside Potential: 18.12%
Based in Hong Kong, Silicon Motion Technology Corporation (NASDAQ:SIMO) stands seventh on the list of best debt-free stocks to buy owing to its solid financial position with zero debt. The technology company specializes in designing, developing, and marketing NAND flash controllers for solid-state storage devices.
Amid the growing integration of electronics and semiconductors across networking communication devices, Silicon Motion Technology Corporation (NASDAQ:SIMO) is one company well-positioned to benefit from the growth. The company delivered solid Q2 2024 results, with revenues increasing to $210.7 million from $140.4 million a year ago. Net income more than doubled to $32.5 million from $12.6 million a year ago.
The impressive results can be attributed to strong demand from PC and smartphone device makers as original equipment manufacturers (OEMs) and a significant 15% growth in revenue from its leading NAND flash client, which now accounts for more than 60% of its total earnings.
Silicon Motion Technology Corporation (NASDAQ:SIMO)’s varied range of products and leadership in technology are projected to lead to a 25-30% increase in revenue each year, with gross profit margins expected to stay between 46-47%. Increasing backlog for the company’s products indicates strong demand. There is growing demand for using the UFS 3.1 and 2.2 controllers in NAND flash. Additionally, the company is experiencing increasing demand for QLC (Quad-Level Cell) UFS products in the mainstream and entry-level 5G smartphone market.
With the core business growing at an impressive rate, analysts on Wall Street rate Silicon Motion Technology Corporation (NASDAQ:SIMO) as a ‘Buy’ with a $94.38 price target, implying an 18.12% upside potential from current levels. As of the end of Q1 2024, 46 hedge funds out of 920 tracked by Insider Monkey held stakes in the company.
6. Rambus Inc. (NASDAQ:RMBS)
Market Cap as of 16/08/2024: $5.03 Billion
Enterprise Value: $4.62 Billion
Upside Potential: 31.78%
Rambus Inc. (NASDAQ:RMBS) is a semiconductor products company that offers DDR memory interface chips and DDR4 memory interface chips to module manufacturers. It also provides a collection of security intellectual property solutions, such as crypto components, hardware foundations of security, fast protocol engines, chip distribution technologies, and patents that span memory design, rapid serial connections, and security items.
Rambus Inc. (NASDAQ:RMBS) ranks sixth on the list of best debt-free stocks to buy, given its low debt level of about $30 million. It has embarked on a new strategy of developing an industry-leading product roadmap for data centers and AI. Consequently, it is projecting a solid third quarter driven by double-digit sequential chip growth again. Revenue in the second quarter increased to $132.1 million from $119.8 million a year ago.
The company is investing strategically in new products and technologies for data centers and devices for clients, showing its belief in expanding the data center and AI sectors. Even though there has been a drop in revenues from the contract and other silicon IP sources due to sales of assets in the previous year, Rambus Inc. (NASDAQ:RMBS) anticipates a growth rate of 10% to 15% in these areas compared to the year before.
While the stock is down by 33% for the year, it trades at a price-to-earnings multiple of 20. The stock is trading at a discount, considering the average P/E in the technology sector is 31. Rambus Inc. (NASDAQ:RMBS) is currently rated as a ‘Buy’ with an average price target of $77.75, implying a 31.78% upside potential from current levels. According to Insider Monkey, the number of hedge funds holding stakes in the company dropped to 25 in Q1 2024 from 29 as of the end of 2023.
In its first quarter 2024 investor letter, Carillon Chartwell Small Cap Growth Fund stated the following regarding Rambus Inc. (NASDAQ:RMBS). Here is what the fund said:
“Rambus Inc. (NASDAQ:RMBS) shares lagged as the company disappointed investors with weak guidance for the first quarter of 2024, due to lower product revenues for the semiconductors it makes. Spending on traditional servers has been lower, replaced by AI spending, which is having a negative impact on Rambus.”
