Monday, October 25, 2010

Learn about Debt to Equity ratios to screen for stocks.

Let's determine if you selected income producing investments with a good balance sheet.

What does that mean? 

How do you determine if your investments have a good balance sheet?

I use many sources to help me determine how to invest. I am trying to narrow my work for you and I recommend that the quickest way for you to get an overall view of your investments' balance sheet strength is to determine the debt to equity ratio (D/E ratio.) 

Go to any financial information site such as your brokerage site maybe at Schwab or Fidelity or use Daily Finance or MoneyCentral.  Type in the symbol of the company in which you have an investment.

Now look under the category Fundamentals or Financial Results. Every site has information on the stock's financial results.  Look through this area and you will find a number called the debt to equity ratio D/E ratio.

Debt is measured just like your personal debt.  How much money does the company owe.  Equity is the value of each share.  Therefore if the debt to equity ratio is 1, the company has a dollar of debt for every dollar of equity.  

Generally speaking, I prefer companies with a D/E ratio less than 1.  However, some companies need to carry a lot of debt to fund major equipment purchases.   If you have a company with a D/E ratio greater than 1 but like all the other aspects of the company, your next assignment is to compare this company with a similar company and to learn about the industry average D/E ratio.   

A good example of this research is to compare Caterpillar (CAT) and Deere (DE).  Each company carries a lot of debt because their equipment is so expensive they cannot pay cash.  CAT has D/E ratio of 2.91 but DE has a D/E ratio of 3.9 and the industry average is 2.2.  So I would pick CAT rather than DE.

I want to emphasize, again, our rules for income investing.  Buy a company that makes money, shares it with you in a dividend, increases the dividend over time and has a strong balance sheet or a low D/E ratio.

Review every stock you own and decide if you have solid companies.  You'll be happy you did your homework.

Very Truly Yours,