UNDERSTANDING SOME LEVERAGE RATIOS

A high level of debt used in funding the operations can be risky for the business, especially in an economic downturn when revenues and profitability reduce. Leverage Ratios can be used to analyse the extent of leverage used by a business and its ability to meet the obligations arising from them. Some of these important ratios are as under:

Debt-Equity Ratio (D/E): High levels of debt in a business can prove to be detrimental for a company. In absence of its ability to pay to the lenders, business may have to face bankruptcy. When businesses create assets aggressively out of borrowed money, it could be quite dangerous if the assets are unable to generate the expected revenues and profitability. The liability will still have to be met.

It would be prudent for investors to avoid companies with extremely high levels of debt. On a most conservative basis, a D/E of 1 or less should be considered as the benchmark, and then depending upon the industry, track record of the company, capital required, project details, should a decision be taken. This ratio is defined as:

D/E Ratio = Long Term Debt / Net-worth

Interest Coverage Ratio: Companies having high debt need to pay high interest as well. Whether a company is headed for a trouble can be simply seen by comparing its earnings with the interest. This ratio, popularly known as Interest Coverage Ratio, tells us how many times the earnings of the business is, with regard to its interest obligation. This is simply defined as:

Interest Coverage Ratio = EBIT / Interest Expense

If this ratio is high, clearly, business is in comfortable zone. The ratio will be less than one or negative in some businesses, which means that earnings are less than interest or earnings are negative and interest obligations exist. As these businesses would be either borrowing money or infusing equity to run the show, these businesses may come into significant problems if they don’t turn around soon.

Debt Service Coverage Ratio (DSCR): The debt service coverage ratio (DCSR) is used in corporate finance to measure the amount of a company's cash flow that's available to pay its current debt payments or obligations. The DSCR compares a company's operating income with the various debt obligations due in the next year including lease, interest, and principal payments. This ratio is defined as:

DSCR = Net Operating Income / Total Debt Service

Comments

THESIS ON CENTRAL DEPOSITORY SERVICES (INDIA) LIMITED (CDSL)

Central Depository Services (India) Limited (CDSL) is very good stock to hold for long-term investors and I am presenting a thesis on it which is as follows: · Its fundamentals are very strong and impressive which can be understood from the following points: Ø It is a debt free company. Ø It has delivered a good profit growth of 24.10% CAGR over last 5 years. Ø It has been maintaining a healthy dividend payout ratio of 42.69%. Ø It has a healthy Cash from Operations. Ø It has a healthy ROE and ROCE of more than 20%. Ø It has a very healthy Operating and PAT Margins of 75.51% and 58.55% respectively as per the financials of F.Y. 2020-21. · The penetration to equity markets in India is still very low as roughly about 3% of India’s population invests in equity markets as compared to 55% in US, which suggests that there’s lots of headroom for India’s stock marketplace penetration to grow. This gives CDSL a great opportunity to grow and benefit fro

UNDERSTANDING ESG FRAMEWORK

Most investors focus on the profit generating ability of a business to make investment decision. However, over the last few years, the societal discussions about companies and businesses have also started focusing on sustainable development, and corporate social responsibility. This has given traction to investment theme that is focused on Environment, Social and Corporate governance (ESG). Initially this framework was used by handful of “Impact” investors. But this framework has gradually gained traction as these frameworks also provide commercial value. Under this framework investors evaluate companies based on these criteria: (i) How does the company’s activities affect the environment? Companies with low carbon emission and low contributors to pollution rank better than others. (ii) What are the activities that the company perform in terms of social development? This includes focus on human rights, gender equality and many such social factors. Companies that contribute more

WHAT ARE DEFENSIVE INDUSTRIES?

These are industries that create products and services that have low income elasticity i.e., a fall or rise in income does not affect the demand significantly. Therefore, these industries experience minimal impact on account of economic cycles. Rather, their business prospects are affected only by secular trends. Food, agricultural inputs, healthcare and pharmaceutical are some of the industries that come under this category. The defensiveness of this industry is the reason why analysts generally suggest to shift to the defensives during a equity market correction.

FINANCE TALKS

Search This Blog