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About 'accounting debt to equity ratio'|A Credible Solution to Europe’s Debt Crisis: A “Trichet Plan” for the Eurozone







About 'accounting debt to equity ratio'|A Credible Solution to Europe’s Debt Crisis: A “Trichet Plan” for the Eurozone








You               face               two               problems               with               fundamental               analysis.

First,               abuses               of               the               past               show               that               you               cannot               rely               on               financial               statements,               even               with               the               "independent"               audit.

Second,               GAAP               (Generally               Accepted               Accounting               Principles)               rules               allow               great               latitude               for               companies               in               how               they               report.

The               solution               is               to               use               three               fundamentals               that               cannot               be               hidden               or               manipulated.

All               depend               on               analysis               of               a               trend               over               several               years               and               not               on               one-year               ratios.

These               are:
               1.

Dividend               growth.

Seek               companies               that               have               increased               their               dividend               every               year               for               at               least               ten               years               ("dividend               achievers").

A               company               must               have               funds               available               to               pay               dividends,               so               this               is               a               great               sign               of               sound               management.

Stocks               of               these               companies               also               tend               to               be               less               volatile               than               average,               and               to               grow               over               time.
               2.

Many               years               of               growth               in               revenues               and               net               profits.

Check               long-term               growth               in               revenue               dollars               along               with               net               return.

If               net               return               slips               while               revenues               rise,               is               indicates               diminishing               control.

As               long               as               net               return               remains               at               the               same               percentage               over               five               to               10               years,               management               is               doing               its               job.

It               is               impossible               to               manipulate               these               outcomes               for               more               than               a               year               or               two.
               3.

A               two-part               test               of               working               capital.

You               might               believe               that               the               current               ratio               is               all               you               need               to               test               working               capital.

This               traditional               test               (comparing               current               assets               to               current               liabilities)               is               valuable,               but               it               is               only               part               of               the               story.

Check               the               debt               ratio               too.

This               is               the               percentage               of               long-term               debt               to               total               capitalization               ("total"               means               equity               plus               long-term               debt).

The               percentage               should               be               holding               steady               or               declining.

Whenever               you               see               the               debt               ratio               increasing               over               the               years,               that               is               a               danger               signal               -               even               if               current               ratio               stays               the               same.

It               could               mean               that               management               is               using               part               of               long-term               debt               to               keep               in               cash               just               to               keep               the               current               ratio               looking               healthy.
               To               show               why               you               need               all               three               tests,               consider               the               case               of               Sears               Holding               (SHLD).

In               each               of               the               last               four               years               going               back               to               2009,               revenues               and               net               income               were               inconsistent:
               In               Millions               of               dollars
               Year               Revenue               Net               Income               net               return
               2012               $41,567               $               -3,113               -               7.5%
               2011               43,326               150               0.3
               2010               44,043               235               0.5
               2009               46,770               53               0.1
               Revenues               fell               erratically               each               year               and               net               return               provided               no               reliable               trend.

Even               with               these               net               losses,               the               current               ratio               remained               between               1               and               2               for               every               year               going               back               four               years.

How               is               that               possible?

Compare               current               ratio               to               debt               ratio               for               four               years:
               Current               Debt
               Year               Ratio               Ratio
               2012               1.1               27.3%
               2011               1.3               22.6
               2010               1,3               14.6
               2009               1.3               10.8
               By               itself,               current               ratio               looks               great.

When               you               also               review               debt               ratio               and               see               it               moving               upward               from               10.8%               to               27.3%               over               four               years,               the               overall               test               is               negative.

This               example               demonstrates               how               to               evaluate               the               fundamentals.

A               test               of               the               long-term               trend               reveals               the               true               strength               or               weakness               of               the               company.
               To               gain               more               perspective               on               insights               to               trading               observations               and               specific               strategies,               I               hope               you               will               join               me               at               ThomsettOptions.com               where               I               publish               many               additional               articles.

I               also               enter               a               regular               series               of               daily               trades               and               updates.

For               new               trades,               I               usually               include               a               stock               chart               marked               up               with               reversal               and               confirmation,               and               provide               detailed               explanations               of               my               rationale.

Link               to               the               site               at               ThomsettOptions.com               to               learn               more.
               I               also               offer               a               weekly               newsletter               subscription               if               you               are               interested               in               a               periodic               update               of               news               and               information               and               a               summary               of               performance               in               the               virtual               portfolio               that               I               manage.

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