Part 1 of the Stock Selection Guide...

Part 1 of the Stock Selection Guide allows investors see how successful management has been in the Past at growing incomes and earnings per share (EPS) Part 2 of the Guide is designed to help investors make judgement about a company's yet to be growth in revenues and EP This is done on assessing management's operational efficiency and effectiveness.

The last issue discussed the Operating Profit Margin (OPM) and in what manner it can be used to assess the efficiency with which a company's management makes and betrays its products. If historical returns and earnings have been growing at a steady pace still the trend in OPM is down, continued hardy growth might be problematic.

The due Ratio is another measure investors can use to help them make senses about a company's potential for hereafter growth in revenues and EPS

Generally, investors value the sensible use of transgression As long as borrowed standard of value can be invested by management to earn a rate greater than its expense the excess return becomes available to used by all shareowners. However, reliance on fault creates a binding obligation to "service" the due by paying interest and repaying principal forward schedule. If a company fails to service its misdoing shareowners will be forced to give up control to creditors-an investor's worst nightmare.

ASSESSING DEBT

The liability Ratio lets investor see what percentage of a company's assets are storeed by borrowed money. It is calculated through dividing a company's total shortcoming (both current and long term) by way of total assets:

(Equation omitted)

Normal due Ratios vary from industry to industry. Predictability of a company's rewards and the ability to have the direction of the price of the company's consequence in the marketplace are key-note determinants of a sensible amount of fault Generally, investors tolerate much higher shortcoming Ratios from companies in industries that are highly regulated (eg utilities) than from companies in emerging, high-risk or cyclical industries.

Usually, investors choose to see moderate Debt Ratios that fluctuate little from year to year. This would indicate that a company is aggressive enough to use one borrowed money to finance its operations and/or recently made known ventures, but prudent enough not to rely excessively upon debt.

HOW DEBT CAN AFFECT yet to be GROWTH

Although a company's management might have a drawn out history of growing both incomes and EPS, an excessive fault load could threaten future growth

Revenue Growth

Often a company wants to take advantage of virtuous business opportunities that come along, or expand its operations at a strategic time. A company's goal in making these kinds of investments is to increase that will be revenues and profits. However, the capital required to invest might not be readily available. In many cases, the company would simply want to borrow the circulating medium it needs. And a company's ability to borrow coin is directly affected by the size of its obligation Ratio. Banks are reluctant to confer money to companies with a high fault Ratio, and when they do loan money, a higher interest rate is usually charged.

When a company carries les offence than it could reasonably handle, it is said to have "unused" borrowing capacity. Unused borrowing capacity will allow a company to borrow money--easily and cheaply--when a well adapted investment opportunity comes along. When a company's liability Ratio is below the normal on a level for its industry or when instant levels are lower than reasonable historical flats the company is typically in a position to borrow more currency if the need should arise.

However, if a company has little or no unused borrowing capacity, it could last up not being able to borrow cash to expand. If the company is repeatedly missing opportunities, continued development in revenues might be difficult to sustain.

EP Growth

By virtue of the fact that trespass threatens future revenue growth, it must also threaten coming time earnings growth. After all, it is nearly impossible to sustain in extent term growth in EPS unles incomes are increasing.

However, EPS are affected according to other factors besides revenues. A company with a high trespass Ratio might continue to shoot revenues but if costs and/or interest rates travel up, serious trouble could arise. For instance, consider the companies illustrated in Table 1 (Table 1 omitted)

Both Companies A and B are in the same business, have the same assets as well as the same returns and operating costs. However, Company A financed alone 10% of its assets with due while Company B financed 70% of its assets with offence During 1994, both companies earned enough to pay the interest upon their debt and still have wealth left over to pay shareowners a dividend. However, in the other year, bad times hit. Although receiptss did go up, so did preciousnesss and interest rates. Despite these increases, Company A was still profitable; however, Company B did not make enough to screen interest expenses. While shareowners of Company A could still receive a dividend, Company B's shareowners are facing the possibility of no cash dividend and insufficient operating profit to service interest payments.