Bullish 4th Quarter revisited
Check the previous posts on this topic here.
Financing a corporation can be done with debt or equity. In most cases, both will be used. If equity is used exclusively, it may dilute the owner's share unnecessarily, but it will not endanger the firm. If debt is used excessively, the stability of the firm could be endangered. Similarly, if the equity portion of the balance sheet declines too much relative to debt, management's ability to raise capital might be affected, threatening the firm. Especially for financial firms which could be overwhelmed by debt and unable to raise new equity due to the depressed share price.
Looking at the S&P 500, the current debt/equity ratio is 0.8 using the value of 1025 or so from August. If SPX rises to 1175, then the debt/equity ratio would be below 0.7. A healthy ratio would be 0.5 or less. If it fell back to 700 then the ratio would be around 1.2. Higher than healthy and more likely to create problems with raising capital. Debt levels would be too high for lenders to feel comfortable and equity levels may be too low for many companies to make raising sufficient capital practical without extreme dilution. So SPX 1175 is not a hard limit, but it is a reasonable level that would allow the SPX companies to lower their debt/equity ratio to a more healthy 0.5 by only suffering a reasonable 30% dilution in equity. The next two months will be very interesting to watch.
Financing a corporation can be done with debt or equity. In most cases, both will be used. If equity is used exclusively, it may dilute the owner's share unnecessarily, but it will not endanger the firm. If debt is used excessively, the stability of the firm could be endangered. Similarly, if the equity portion of the balance sheet declines too much relative to debt, management's ability to raise capital might be affected, threatening the firm. Especially for financial firms which could be overwhelmed by debt and unable to raise new equity due to the depressed share price.
Looking at the S&P 500, the current debt/equity ratio is 0.8 using the value of 1025 or so from August. If SPX rises to 1175, then the debt/equity ratio would be below 0.7. A healthy ratio would be 0.5 or less. If it fell back to 700 then the ratio would be around 1.2. Higher than healthy and more likely to create problems with raising capital. Debt levels would be too high for lenders to feel comfortable and equity levels may be too low for many companies to make raising sufficient capital practical without extreme dilution. So SPX 1175 is not a hard limit, but it is a reasonable level that would allow the SPX companies to lower their debt/equity ratio to a more healthy 0.5 by only suffering a reasonable 30% dilution in equity. The next two months will be very interesting to watch.
posted by Matt Butler at 11:05 PM
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