| Be partial to companies with little or no debt, here is | | | | has. (Equity is net assets plus retained earnings.) Debt |
| why. Paying interest on loans lowers net earnings. | | | | should be less than 50% of equity. A company's total |
| And it can add substantial uncertainty to a company's | | | | debt and shareholder's equity can be found on the |
| risk profile. If a company can't pay its loans, that can | | | | balance sheet of a company's financial report. |
| be the beginning of a slide into bankruptcy. But even | | | | For banks, real estate companies, and REITs (real |
| if a company can pay off its loans, it can find itself in | | | | estate investment trusts), debt is unavoidable given |
| serious trouble with the bank. It's not just about the | | | | the nature of these businesses, so this metric can't |
| money, but about the terms. Banks can impose | | | | be used quite the same way. |
| many conditions on loans - for instance, specifying | | | | Regardless of a company's D/E, you should always |
| how much cash flow the company has to generate | | | | delve into its annual and/or quarterly reports and look |
| to meet its debt and interest obligations. Such | | | | up how well its loan repayments are spaced out in |
| conditions are called covenants. And they can make | | | | future years. They're never perfectly even. And for |
| the CFO of a company go gray faster than Bill | | | | those years when loans mature and become due, |
| Clinton. | | | | there can be dramatic jumps in a company's debt |
| Financially conservative companies expand by using | | | | service burden. A big jump can be a red flag, |
| their retained earnings rather than getting bank loans. | | | | depending on when it is (the further away, the |
| Or they issue shares. A company's debt-to-equity | | | | better), the company's ability to pay, and the lending |
| ratio (or D/E) can tell you how much debt burden it | | | | climate as the deadlines grow nearer. |