A variety of stock valuation statistics can be used to evaluate a company together with the debt / capital ratio to get a more complete picture of the company’s viability as an investment.
The debt-to-equity ratio can be used as an alternative measure to evaluate the debt situation of a company. This ratio measures how much financial leverage a company has, so that a company’s total liabilities are divided by its equity. When the debt / equity ratio is high, this usually indicates that the company has used a substantial amount of debt to finance its growth. However, large amounts of debt financing may potentially generate higher revenues, which could be sufficient to offset debt costs and still return shareholders’ equity to shareholders. On the other hand, the cost of debt financing can also overburden the returns generated by the company and may be too much to sustain.
Perhaps more important than the total debt of a company is its ability to pay its outstanding debt. Debt itself is not a problem as long as the company can make the required payments. Neither the debt / capital ratio nor the debt / equity ratio factor in a company’s ability to cover its debt or that companies borrow at different interest rates. The interest coverage ratio takes these factors into account. Instead of just looking at the total debt, the calculation for this statistic includes the costs that a company pays in interest because it relates to the company’s operating result. The formula for this ratio divides the operating result of a company by its interest charges; a higher figure is better. Generally, an interest coverage ratio of 3 or higher indicates that a company has a strong ability to cover its debt, but acceptable ratio levels vary between industries.
A number of profitability ratios can be used to evaluate the performance of a company with regard to generating profit, such as the return on equity ratio and the return on assets ratio. The return on equity ratio measures the actual profit of a shareholder on his investment in a company. The return on capital ratio is broader and shows how profitable a company is in relation to its total capital. This statistic helps assess how well a company’s management uses its total assets to make a profit. Calculating this value compares the net result of the company with the total assets. When the resulting value of the return on capital ratio is higher, this indicates that the company’s management is using its asset base more effectively.
These and other equity measures can be used to get an overall assessment of the financial health and performance of a company. Investors should never rely on one evaluation statistic, but must analyze the company from different perspectives.