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Important Debt to Equity Ratio Analysis

Fellow spreadsheet and investing enthusiasts, the world of Wall Street is open for understanding. There’s no better way to learn the stock market than to dig into the financial statements. However, there’s some important details within this process to be aware of, especially concerning debt to equity ratio analysis.

debt to equity ratio analysis

Here’s a great email question from a reader that should help everyone following along. Whether you are doing debt to equity ratio analysis, cash flow analysis, or even just looking at P/Es, this knowledge should help you get a bigger picture at what the numbers mean and how much analysis is really necessary.

Good Afternoon Andrew,

First and foremost, I apologize if this email is a little “rookie” sounding. I am still new to investing (started about 9 months ago) and have been following your guidance the entire way. I just read one of your latest posts about looking for stocks that have increased their dividend payment over the last 10 years.

With that being said, I started to do some research and found a company that looked intriguing ($BRO if you care.) I was looking over the financial statements (latest 10K from FY 2014) and I noticed something that through up a amber flag for me. I was always told when looking at the cash flow statement for a company you want to see a significant positive value in the Operating Activities section, and negative values in the Investing and Financing Activities sections.

With this company, the Operating Activities and Investing Activities were good but the Financing Activities held a significant positive value. Almost all of the positive value came from “proceeds from long term debt”. With that being said, although they took on a significant amount of debt in 2014 they are still only at a .53 D/E. Additionally they had a positive value in 2012 and then a negative value in 2013. When looking at the latest 10Q, the Cash Flow statement in in the negative for the 9 months of FY 2015.

I am overthinking this positive number? In other words, just because the company took on debt last year should that prevent me from purchasing the stock? I appreciate any insight you can provide. Thank You.

Brandon


When I’m looking at Cash Flow numbers, I don’t try to over analyze it. As long as the P/C is reasonable (10 or lower, but 10-30 is also ok), that’s usually enough for me. Debt to Equity is more important in my opinion. However, be careful with insurance and financial companies like banks.

The debt to equity ratio posted on financial websites like FINVIZ sometimes doesn’t tell the whole picture, which is why I always run the calculation myself.

There’s many ways to calculate Debt to Equity, but the way I do it takes Total Liabilities / Total Shareholder’s Equity. As long as that final number is low, you know that the company is readily able to cover its liabilities with sufficient assets.

Of course, you always want to make sure that the health of other financial statements is sufficient too. If you want the whole picture about which specific numbers I calculate, I recommend using my Value Trap Indicator spreadsheet. It’s the final checklist I use with every single stock I purchase.