124 ShowMetheMoney
on its capital, borrowing is profitable. Shareholders benefit. There is
a limit to the benefit, however, for even relatively cheap money must
be repai dan dtoo great a debt bur den coul dbe crushing during
periods of depressed returns.
A way to gauge these trade-offs is to examine the coverage ra-
tio—a comparison of earnings to interest obligations on debt. For
most industrial companies, an interest coverage ratio in the range of
3 to 4 is considered prudent and implies a relatively safe level of
borrowing. In light of the relatively low levels of indebtedness and
relatively high levels of profitability of corporate America at the turn
of the twenty-first century, the average interest coverage ratio among
the S&P 500 soare dto nearly 11.
Conglomerates remaine dclosest to historical norms, with GE’s
coverage ratio at about 2.5 an dthe segment at about 4.5. At nearly
the other extreme, Microsoft enjoys total coverage because it is sim-
ply debt-free. Amazon.com is an interesting case: Its coverage ratio
is negative because it is losing money (has negative profits), as low
as4. That kin dof situation calls for looking more closely at other
fixe dcharges, which in Amazon.com’s case inclu de leases on various
warehouses that also have to be paid. Its fixed charge coverage ratio
is therefore even worse, making its ability to generate additional
funds to cover its increasing expansion all the more important.
MANAGERS UNDER THE MICROSCOPE
Three simple tools clue us into managerial effectiveness. They center
on the efficiency of inventory an dreceivables management an dthe
thickness of profit margins. Some companies report the spee dof
inventory an dreceivable turns an dthe levels of profit margins di-
rectly in their periodic reports, and some even highlight this in the
chairman’s letters—usually signs of goo dor at least honest manage-
ment. In other cases, you have to dig for it (not a good sign). Putting
managers under the microscope this way helps gauge the prospects
for future business performance—whether the maximal profits are
being squeeze dfrom the business or whether there is room for more.
Inventory Turns
While inventory is considered a current asset in that it is expected
to be realize din cash within one year, you can be more precise about