In addition to the debt-to-capital ratio, a number of other valuation metrics can be used to evaluate a company and develop a more complete view of its viability.
Debt to Equity and Interest Coverage Ratio
The debt-to-equity ratio is one alternative to evaluate a company's debt situation. This ratio measures financial leverage, dividing a company's total liabilities by its shareholder equity. A company with a high debt-to-equity ratio generally indicates it has used a significant amount of debt to fund growth. However, this by itself isn't necessarily bad. Debt financing can boost earnings, which could potentially outweigh debt costs and return equity to shareholders. Nevertheless, debt financing costs could also overwhelm any returns and may be too high for a company to sustain.
This is why it's important to look at a company's total debt in conjunction with its ability to service that debt. The interest coverage ratio is a useful tool. The ratio measures how easily a company can pay interest on its debt. It's calculated by dividing a company's earnings before interest and taxes (EBIT) by its interest payments due. A higher number is better. Typically, an interest coverage ratio of 3 or higher indicates a company with a strong ability to cover its debt, but acceptable ratio levels vary among industries.
Return on Equity and Return on Assets
A number of profitability ratios can be used to evaluate a company's ability to generate profits, such as the return on equity (ROE) ratio and the return on assets (ROA) ratio. Return on equity is calculated by dividing net income by shareholder equity. The measure indicates how well management is using assets to create profits.
Likewise, ROA also helps investors to gauge whether management is efficiently using company assets to generate earnings. ROA expresses how profitable a company is relative to total assets. ROA is stated as a percentage. Take the company's net income and divide by its total assets. A higher value indicates management is utilizing assets effectively.
These and other equity measures can be used to gain an overall picture of a company's financial health and performance. Investors should never rely on a single metric, but instead analyze a company from a variety of perspectives.