When taking significant amounts of debt into consideration I would do the following:
a) as mentioned above, ensure that debt is no greater than a certain multiple of earnings (I also use 5 times)
b) to ensure that the balance sheet is not window dressed, ensure that interest cover is adequate (say, 4 times)
c) Instead of using return on equity, use return on capital employed i.e. the returns that would be achieved with an unleveraged business. This would be the returns with interest excluded i.e. net operating profit after tax (operating profit x (1 minus tax rate)) divided by shareholders' equity plus debt.
Sunday, January 30, 2011
TMF: Re: Doughty Dozen, meet the Fallible Fifteen / High Yield - HYP Practical