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Lesson 12. Evaluating Stocks > The Price/Earnings Ratio - Pg. 71

Evaluating Stocks 1. 2. 71 3. He's obviously managing his money better than you are (better management). Thus, I'm con- vinced he's going to handle my (loaned) money more responsibly than you will. He's got a much lower debt percentage to carry than you do. All other things being equal (for both of you, rent = 25 percent of your take-home pay, food = 20 percent of your take-home pay, etc.), you are paying a higher relative loan percentage, even though you are also making more money. And struggling to make debt payments of 50 percent is really struggling. I've got a better chance of getting some of my money back from your brother should both of you go out of business or, in this case, declare bankruptcy. Remember again that we're work- ing on percentages here. Remembering that taxes, fees, etc., are usually based on a per- centage rather than the amount, your brother would be liable for only about 10 percent of his total income; whereas you would be liable for half. I'll take my chances with your brother. Assets ÷ Liabilities = Current Ratio So the formula to determine the current ratio is ... This current ratio would indicate the probability that in the case of insolvency (bankruptcy), the investor would get all or some of his or her money back after all debts, bonds, and preferred stock were paid off. On the flip side, the formula to determine the debt ratio is ... Amount Owed to All Outstanding Bonds ÷ The Company's Total Capitalization = Debt Ratio This debt ratio would indicate the company's ability to meet the payments of the debt it carries, or how close the company is to bankruptcy. Using this ratio together with the current ratio, an investor