Debt Evaluation Ratios

Will you invest in a company that has a large amount of debt? That is a usual question that you would hear from every investor when they are evaluating a stock. Unfortunately, the answer is not either a “yes or no.” The actual answer is “it depends.” Because the problem is that there are some industries that typically require more debts than others do. For these industries, a higher debt load is normal.

For other industries; a large amount of debt may be a sign that something is seriously wrong.  Of course, any company might pick up a large amount of debt if it had just bought a building or a competitor. When selecting stocks to place in your trading system, it is important to determine if the company has too much debt.  There are actually several tools that you can use to determine whether a company is about to expose itself to too much debt and this tool is the stock evaluation tool and these are:

The first tool is the Debt to Equity Ratio. This is a ratio that tells you of what portion of debt and equity is being used to finance a company’s assets. The formula to do that is by computing the Total Liabilities / Shareholder Equity = Debt to Equity Ratio.

The second tool is the metric tool called the Interest Coverage that will actually provide you a good idea of how a company is having trouble in terms of paying the interest charges on its debt. The formula in computing the metric of the debt with the Interest Coverage is by computing the EBITDA / Interest Expense = Interest Coverage.

Another tool would be the Current Ratio.  This ratio tells you how easily a company is able to pay their liabilities that will come due within the next year.  The amount of debt a company is required to pay out within the next year and is known as the current maturity of debt is posted as an amount in the current liabilities, or the debt due in the next year.  Thus the current ratio will not only include things like the small debts owed by the company but also reflect whether they can meet their principle payments for the coming year.

It is important when deciding if you should buy shares in a companies stock that you know if they are living on the edge and may have to file bankruptcy because of not being able to pay their debts.

Don’t Forget the Cost of Selling Stock Certificates

When newcomers to the stock market invest they are almost invariably surprised by the amount of commissions they pay.  Active stock traders can pay many thousands of dollars in commissions in a single year.  In order to accurately forecast what your returns might be, you must remember to add in the commissions on both sides of your trade.  You will be paying a fee when you sell stock in addition to the fees you pay when you purchase your shares.

As you become a more active trader, the percentage of your profits that will be allocated to paying commissions goes up.  An active trader can easily make 10 trades a day.  If this trader is paying $10 per trade he is spending $200 just in commissions.  This means that in order for the trader to break even for the day he must be $200 to the good on his stock trades.  It is a common mistake to only factor in one side of the cost of the trade.  Many people would just multiply the number of trades (10) by the cost per trade ($10) to get the estimated fees.  As you can see you must double this result to account for selling stock certificates.

Taking note of the example above it makes it very clear that an active trader would save a large amount of money if he used a cheap stock trading brokerage.  There are many good discount brokers available online.  Some of the more well respected brokers are:  Scottrade, Charles Schwab, etrade, and Trade King.  It takes a certain amount of research to keep up with the different pricing schedules available from the different brokers.  As you can see by the $200 per day cost, a little research can save a lot of money.  Don’t simply choose a broker based on their prices, but don’t ignore them either.  Saving $100 or more every day could make the difference between being a profitable trader and losing money for the year.

A Simple Crossover

The most referred to cross over is the 50 day simple moving average (SMA) crossing the 200 day SMA.  This is an early indication of a short term trend change turning into a long term trend change in the stock market.

You calculate the 50 day SMA by averaging the closing prices for the last 50 days of a stock, then you average the last 200 day for the 200 day SMA.  When the 50 day goes from small then the 200 day to larger then the 200 day you have a bullish signal, larger 50 day to smaller you get a bearish signal.

This is a common entry/exit point for many investors and traders alike.  Moving average cross overs tied with chart patterns and strong fundamental analysis can be a powerful investor combination.  If you use this cross over I suggest using a stop loss 1 – 2% under the 200 day SMA price.  You don’t want your stop loss so close the the resistance that you get whipsawed when the support is tested, but also not so low that you lose your shirt if the cross over was false.