We know rates have been rising and are at their highest level in over 10 years. When using the Screen Tool to identify stocks you can also use criteria to help avoid stocks. Given rates are high, this may be prudent to add such a criteria to help refine your lists further while reducing your exposure to interest rate risk. Below we will discuss some of them.
Stocks with high long term debt to equity
The ratio is calculated by taking the company's long-term debt and dividing it by the book value of common equity. It can be found in the Screen Tool.
The greater a company's leverage, the higher the ratio, and therefore more risk. A highly-geared company is more vulnerable to a sudden bump in the road, either operationally or due a change in the economy such as an increase in interest rates.
By using long-term debt alone rather than including short term debt means we measure the component of debt which is compounding and can lead to significant strain if left unchecked. That said, if possible, spend some time assessing whether there is any debt required to be refinanced into the near future. Doing so now will mean a higher rate of interest than what they had previously paid.
Note: due to the way accounting works there will often be nonsensical results. For example, stocks can have accumulated losses which result in very high debt to equity ratios as the accumulated losses are subtracted from the equity value (eg Qantas Airways (ASX:QAN) has a long term debt to equity over 42,000% as the equity value is so low (and planes are very expensive.)
Also some penny dreadful mining companies have very low debt to equity. But that is because they don't make any money, so who is going to lend them money in the first place? But there are many other risks these businesses carry that need to be assessed beyond debt/equity.
This can also throw up notoriously strange results for Financials businesses as obligations to clients/members are seen as liabilities. Therefore don’t read too much into the LTDebt / Equity on these businesses.
Stocks with a poor AltmanZ score
The whole premise of the Altman score is to identify stocks that could…
