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Leverage Ratio in Stock Market

FINANCIAL LEVERAGE RATIOS

Leverage ratios are much important while performing the fundamental Analysis in stock market. The so called, Leverage Ratios in Stock Market can be calculated in few ways.

As we are aware, the EPS of a company is a Profitability ratio. The Leverage ratio is falling under Financial ratios. Financial Leverage Ratios involve a group of ratios that estimate the leverage of a business. These ratios estimate the amount of the company’s capital comes from debt. As a result, we can identify the riskiness of a business.

A company with a lower financial leverage ratio uses revenue from its sales to develop the business, even though they have debt. On the other hand, a company with a higher financial leverage ratio uses its debt for development.

Generally, considerable leverage ratios are between 0.1 and 1.0. A business with 0.1 ratio has nearly no debt relative to equity. Contrastingly, a business with 1.0 ratio has debt almost equal to equity. 0.5 ratio is a common one in businesses with twice as assets than its liabilities. The higher leverage ratios are mostly among firms with higher production costs.

CALCULATION OF LEVERAGE RATIO

Calculation of a few financial leverage ratios are given below.

  • Net Leverage RatioThis is the ratio of a business’s debt to its earnings.

                        Net Leverage Ratio= (Net Debt- Cash Holdings)                                                                                  EBITDA                 

EBITDA= Earnings Before Interest, Taxes, Depreciation and Amortization.

  • Debt to Equity Ratio: This is the ratio of the total liabilities of a company to the equity of its stockholders.

Debt to Equity Ratio=          Liabilities                                                                                     Stockholder’s Equity

  • Operating Leverage Ratio: This is the ratio of the contribution margin of a company to its net operating income.

        Operating Leverage Ratio= % change in EBIT                                                                               % change in Sales

EBIT= Earnings Before Interest and Taxes.

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