Interest Expense is the amount of interest a company paid during the same reporting period on the debt it carries on its balance sheet. This will be deducted from its operating income.
The company may also earn interest on the cash it carries on its balance sheet. This will be added to its income.
Ben Graham required that a company must have - at minimum - produced average earnings at least five times the interest expenses. This means that the companys operating earnings needs to be at least five times higher than interest expenses.
Companies with high interest expenses relative to operating income tend to be either:
1) in a fiercely competitive industry where large capital expenditure required to stay competitive
2) a company with excellent business economics that acquired debt in leveraged buyout
Companies with durable competitive advantages often carry little or no interest expense.
Warrens favorites in the consumer products category all have less than 15% of operating income.
Interest expenses varies widely between industries.
Interest ratios can be very informative of level of economic danger.
Important: In any industry, the company with the lowest ratio of interest to Operating Income is usually the one with the competitive advantage.
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