{"id":2115,"date":"2008-07-19T22:33:42","date_gmt":"2008-07-20T03:33:42","guid":{"rendered":"http:\/\/magic1host.com\/blog\/2008\/07\/19\/the-power-of-ratios-for-successful-stock-investing\/"},"modified":"2008-07-19T22:33:42","modified_gmt":"2008-07-20T03:33:42","slug":"the-power-of-ratios-for-successful-stock-investing","status":"publish","type":"post","link":"https:\/\/magic1host.com\/blog\/?p=2115","title":{"rendered":"The Power of Ratios For Successful Stock Investing"},"content":{"rendered":"
by Martin Sejas<\/div>\n

The 4th installment of this publication concerns the debt\/equity ratio, another major cog of Warren Buffett’s classical investing strategy. In reality, it is an element that the master himself deals with very cautiously when it comes to decide which stocks to put money in. Similar to the return on equity in the 3rd installment of this publication, it is an formula that is typically employed in finance, nevertheless, Buffett uses it more effectively that anyone else.<\/p>\n

The elements that comprise the debt\/equity ratio are clearly evident and it’s very likely that many people first got acquainted with it in secondary school in a commerce subject. Nevertheless, some confusion may still reign, hence I will give a simple, short explanation. The debt\/equity ratio is calculated by dividing total liabilities by shareholders’ equity.<\/p>\n

Both total liabilities and shareholder’s equity can be found on a company’s balance sheet (sometimes known as the statement of financial position). This is known as taking its ‘book value’. On the other hand, if the concerned company’s debt and equity are publicly traded, you can use the market value instead. There is also the possibility of using a mixture of both the book and market value.<\/p>\n

The ratio shows the proportion of equity and debt the company is using to finance its assets, and the higher the ratio, the more debt (rather than equity) is financing the company. The main problem with having a high ratio (a high level of debt compared to equity) is that it can result in volatile earnings and large interest expenses.<\/p>\n

In fact, Buffett takes the results of this ratio very seriously and it’s very educational to comprehend the reasons why. Like all investors, he wants a company to only possess a tiny quantity of debt and the reason why is that a tiny quantity of debt indicates that growth in income is being yielded from shareholders’ equity contrary to borrowed money. If a company utilises borrowed money to finance its income, this usually forms a vicious cycle of debt and repayments which is unstable and which is dependent on interest rates.<\/p>\n

The lesson to digest from Buffett is to focus your efforts on companies that have a low ratio, or at the least a ratio which is low compared with other firms in the same industry. All that’s needed from your part is to calculate the ratios for each company, but as I pointed out previously, the necessary information is often available on company reports.<\/p>\n

Many investors prefer to use long-term debt rather than the traditional component, total liabilites, when they are calculating the ratio. According to many, this could prove to be more effective and convenient due to the long term nature of stocks investing. Among these people, Buffett is one of them.<\/p>\n

The final part of this series will focus on the left over element of Buffett’s methodology – profit margins, an underestimated concept in finance today. Keep your eye out for it!<\/p>\n

\n
About the Author:<\/div>\n
About the author: Martin Sejas is the owner<\/a> of Stocks-And-Commodities.com, a leading stocks trading<\/a> website dedicated to finding the best and the latest strategies and techniques for stocks and commodities<\/a> trading. Its goal is to become the ‘one-stop shop’ on the best stocks trading websites and programs on the World Wide Web.<\/div>\n<\/div>\n","protected":false},"excerpt":{"rendered":"

The 4th installment of this publication concerns the debt\/equity ratio, another major cog of Warren Buffett’s classical investing strategy. In reality, it is an element that the master himself deals with very cautiously when it comes to decide which stocks to put money in. Similar to the return on equity in the 3rd installment of this publication, it is an formula that is typically employed in finance, nevertheless, Buffett uses it more effectively that anyone else.<\/p>\n","protected":false},"author":1133,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[3],"tags":[77],"class_list":["post-2115","post","type-post","status-publish","format-standard","hentry","category-business","tag-business"],"_links":{"self":[{"href":"https:\/\/magic1host.com\/blog\/index.php?rest_route=\/wp\/v2\/posts\/2115","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/magic1host.com\/blog\/index.php?rest_route=\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/magic1host.com\/blog\/index.php?rest_route=\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/magic1host.com\/blog\/index.php?rest_route=\/wp\/v2\/users\/1133"}],"replies":[{"embeddable":true,"href":"https:\/\/magic1host.com\/blog\/index.php?rest_route=%2Fwp%2Fv2%2Fcomments&post=2115"}],"version-history":[{"count":0,"href":"https:\/\/magic1host.com\/blog\/index.php?rest_route=\/wp\/v2\/posts\/2115\/revisions"}],"wp:attachment":[{"href":"https:\/\/magic1host.com\/blog\/index.php?rest_route=%2Fwp%2Fv2%2Fmedia&parent=2115"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/magic1host.com\/blog\/index.php?rest_route=%2Fwp%2Fv2%2Fcategories&post=2115"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/magic1host.com\/blog\/index.php?rest_route=%2Fwp%2Fv2%2Ftags&post=2115"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}