When investing, you will be facing risk. The higher the risk, the higher the return you will get. When you are buying stocks, you are facing the risk of losing your money. Risk can be measured with beta. Higher beta means, it has high risk because volatility is high. Stocks with beta more than one, will have high correlation with the market index. Therefore, if the market index is going up, the stocks with beta more than one will likely be up too. If we are in a bull market, you should buy stocks with beta more than one. In addition, if we are in a bear market, you should buy stocks with beta less than one. These stocks are also called defensive stocks.

Tags: beta, defensive stocks, Measuring risk, Risk

To measure the safety of a company, we use the debt to equity ratio (D/E). It is a financial ratio indicating the relative proportion of equity and debt used to finance a company’s assets. This ratio is also known as Risk or Gearing. It is equal to total debt divided by shareholders’ equity. The two components of debt
and equity are often taken from the firm’s balance sheet, but the ratio may also be calculated using market values for both, if the company’s debt and equity are publicly traded, or using a combination of book value for debt and market value for equity.

A high debt/equity ratio generally means that a company has been aggressive in financing its growth with debt. This can result in volatile earnings as the result of interest expense. If a lot of debt is used to finance increased operations, the company could potentially generate more earnings. If this earnings is greater
than the debt cost (interest), then the shareholders will benefit. However, if the cost of this debt outweight the return that the company generates on the debt through investment and business activities, the company can go bankrupt.

The debt/equity ratio depends on the industry in which the company operates. For example, capital-intensive industries such as auto manufacturing tend to have a debt/equity ratio above 2, while personal computer companies have a debt/equity of under 0.5.

Tags: debt to equity ratio, financial ratio, Gearing, Risk