RecognizingSuccess 123that neither GE, Microsoft, nor Amazon.com is all that different
from its segment in terms of liquidity needs or how they are being
met.
Debt
Check out a company’s ability to attract additional financing; this is
particularly important when a company has negative working capital
from issuing short-term obligations such as commercial paper. This
is done by using thedebt-to-equity ratio. In its most general formu-
lation, the calculation is the ratio between the total debt of a com-
pany, including short-term debt as well as long-term debt, divided
by the amount of owners’ equity.
The ratio measures the relative borrowing capacity an d debt-
paying ability of the enterprise over the long term. Businesses with
relatively high debt-to-equity ratios are characterized as “highly lev-
eraged,” meaning that the debt level in relation to the investment
level of the owners in the business (the shareholders) is very high.
What levels of debt-to-equity ratios are normal has varied histori-
cally, in accordance with economic conditions and collective beliefs
about credit.
During the 1980s, for example, debt-to-equity ratios in the range
of 7:1 or higher were common, whereas during the early 1990s the
typical ratios were closer to 4:1. At the turn of the twenty-first cen-
tury, the debt-to-equity ratio of the S&P 500 averaged just about 1:
1, reflecting a decade in which most business financing was done
using equity rather than debt.
Conglomerates still are relatively debt-heavy, however, with the
segment average of about 3:1 an dGE above that segment average
with a debt-to-equity ratio of around 4:1. That level reflects the rel-
atively more mature stage of these companies, particularly compared
with the far leaner computer industry. Microsoft, for example, funds
all its operations with internally generate dcash, enabling it to op-
erate with no debt whatsoever, and the average debt-to-equity ratio
for the computer industry as a whole is a staggeringly low .2:1. Am-
azon.com weighs in between these levels, reflecting both its nee dto
finance its expanding operations and warehouse construction pro-
jects an dits relatively lesser ability compare dwith Microsoft to gen-
erate sufficient cash to satisfy those needs.
Leverage reflecte din a relatively higher debt-to-equity ratio can
be desirable. If a company borrows at rates below what it can earn