Gearing, Cover

This panel of figures gives an insight into the structure of a company's balance sheet. In particular, the overall level of borrowings (gross gearing), how much is short and long-term, borrowings less cash (net gearing), short-term liquidity and the cash position (if any). Other useful statistics include the extent to which interest payments are covered by profits and dividends by earnings.

The first column of figures, headed Incl, shows the percentage of net gearing, cash, gross gearing and one- and five-year gearing in relation to shareholders' funds (share capital plus reserves, less preference capital redeemable within 12 months). The second column, headed Excl, is a much harsher measure, as all intangibles, such as brand names, copyrights and goodwill, have been excluded from shareholders' funds.

Net gearing is expressed as the percentage of total borrowings (less cash) to shareholders' funds (less intangibles). A minus figure indicates nil net gearing and denotes a net cash position, which is also expressed as a percentage of shareholders' funds less intangibles.

The cash percentage figures also include near cash assets such as treasury bills and certificates of deposit. Marketable securities are not included in near cash. This is a harsh measure which assumes that they may be difficult to realise in an emergency.

There are several reasons why investors should be particularly aware of the perils of high gearing:-

1. Any company with high gearing, which includes bank and other short-term borrowings, is likely to be very sensitive to changes in interest rates.

2. A highly-geared company can be very vulnerable, and can fail completely, during a liquidity crisis, especially if most if its borrowings are short-term. There is no substitute for cash in the bank when a gale is blowing through world financial markets.

3. The results of highly-geared companies tend to exaggerate the underlying trend. All shareholders' funds are invested, and further substantial borrowings result in the company being full committed and therefore subject to prevailing winds. When businesses are recovering, high gearing can be a massive advantage for shareholders, but the reverse is also the case in tougher times.

It is difficult to set a firm guideline for gearing. Much depends on whether a company's borrowings are short or long-term, on the outlook for its industry and the efficiency of its management. Generally speaking, net gearing of over 50% calls for more detailed investigation. This is especially the case if a large proportion of the overall borrowings are short-term.

A company with a high dividend yield, low dividend cover and high gearing is often on the brink of trouble.

Quick Ratio
The quick ratio is an attempt to indicate what would happen if a company suddenly had to pay off all its current liabilities. For this reason, only assets that can be readily turned into cash are included and stock and work-in-progress is excluded.

The basic formula is therefore:

Current assets less stock and work-in-progress	= quick ratio
Current liabilities

Generally speaking, I like to see a quick ratio of over one, but many retailing operations can manage on much less, as they can sell their products several weeks before paying their suppliers.

Current Ratio
This ratio is determined by dividing the current assets of a business by its current liabilities. The resultant ratio shows the number of times current liabilities are covered by current assets. The basic formula is therefore:

Current assets	= current ratio
Current liabilities

A high ratio (2 or more) is usually a sign of financial strength and a low ratio (1.25 or less) can be a sign of financial weakness.

Also, the year by year trend of current ratios can alert investors to fundamental changes in a business's financial structure. Retailing companies usually have small debtors, as most of their sales are paid for in cash; therefore, they usually have lower than average current ratios. In other industries, large current ratios can sometimes result from excessive stocks or poor control of debtors.

Interest Cover
This ratio is calculated by taking a company's normalised historic profits before interest and taxation and dividing them by the annual interest charge. The resultant figure indicates the company's capacity to continue paying interest on its borrowings out of annual profits.

The basic formula is therefore:

Normalised profits before taxation and gross interest	= interest cover
Annual gross interest charge

Low and/or deteriorating interest cover is an obvious danger signal and can sometimes be a precursor to reconstruction, fund-raising or business failure.

Key Dates

KEY DATES appear to the bottom right of the entry in a small panel like this one:-

Key dates are particularly important for fast-growing smaller companies, which usually have their moment in the sun around the time of their preliminary and interim results. The AGM date is also of vital importance as the chairman frequently uses the meeting to make a statement about future prospects.

A company growing at say 30% per annum on an historic PER of 20 (a PEG of 0.66) would attract immediate investment interest when it announced another year of 30% growth, coupled with an optimistic forecast. The historic PER would then cease to be of real interest and attention would focus on the prospective PER for the year ahead. If the consensus forecast was for another 30% growth in earnings, the prospective PER would fall to about 13 (provided the share price remained constant). For a company growing at 30% per annum, this would clearly be a bargain and the shares would almost certainly rise sharply.

Of course, the shares were cheap a month before the results. However, the announcement turned fancy into fact and the focus of interest switched immediately to the following year. 

This principle applies to all companies, but is exaggerated with fast growing smaller companies.

Most of the research material and press comment on them is relatively sparse except when they are announcing their results and having their moment in the sun.

The ex-dividend dates are of particular interest to income funds and income-conscious investors.

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