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com 
November 3, 2009 
 

Introduction to Credit Risk Analysis: Debt‐to‐
Equity Ratio 
If recent financial market events have taught us anything, it's that a) leverage can work both
ways, and b) when leverage works against an individual/corporation/investment entity, the
results can be fairly disastrous. Although the pair of statements above are essentially commonly
held knowledge, the behavior exhibited by market participants throughout the past 20 years was
nothing if not a blatant disregard for this reality. Moving forward, it will be more prudent than
ever for investors to perform a sober assessment of a corporation's use of leverage.

At the heart of credit risk analysis is a corporation's solvency, or in other words, it's ability to
function as a going concern, capable of avoiding financial distress. The cornerstone of
evaluating solvency is the Debt-to-Equity Ratio, which as the name implies, looks at a firms
absolute debt level in terms of a multiple of total stockholders' equity. Both parts of the equation
can be found on the balance sheet, and are plugged in as follows:

Debt-to-Equity Ratio = Total Liabilities / Total Stockholders' Equity

Verizon's (VZ) Debt-to-Equity Ratio is calculated as follows:

Debt-to-Equity Ratio = Total Liabilities / Total Stockholders' Equity
= $160,646M / $41,706M
= 3.85
 
In other words, for every dollar of Shareholders' Equity, Verizon holds $3.85 worth of debt. This
ratio will obviously fluctuate greatly based upon the industry, and the composition of the firm's
funding sources, i.e. relative breakdown of debt v equity funding. The chart below compares
Verizon with seven other large firms from a debt-to-equity ratio standpoint: 
http://TheValueatRisk.blogspot.com 
November 3, 2009 
 
 

Clearly, the debt-to-equity ratio needs to be examined from within the context of the individual
firm and industry as a whole. For instance, there are two reasons why I wouldn't be alarmed at
Verizon's high ratio of debt funding. First, it's subscriber based business provides relatively
stable and predictable cash flows; a distinction that translates into ample access to the bond
market. Secondly, a major portion of Verizon's borrowing activity over the past couple of years
has been geared towards investment in it;s FiOs network. I haven't assessed that product from
a consumer standpoint, but feel certain that Verizon will be able to leverage it's market
leadership position into a substantial FiOs subscriber base.

Step 2 in the credit risk analysis process is determining the firm’s ability to cover interest
payments from internally generated cash. That ratio will be addressed in a future article.

*no positions 

Copyright 2009 ‐ The Value at Risk  

 
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November 3, 2009 
 
 

For additional analysis of financial markets and politics, or to view information about the author, please visit 
http://TheValueatRisk.blogspot.com 

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