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Stingy Investor Tip Sheet

Synthetic Debt Ratings

Aswath Damodaran worked out a simple way to find a firm's debt rating. He determined that debt ratings primarily, and overwhelmingly, depend on interest coverage ratios. Calculate the ratio and you can determine debt ratings with reasonable precision.

The interest coverage ratio is calculated by dividing EBIT by interest expense. EBIT is earnings before interest and taxes. As one might expect, higher ratios lead to higher debt ratings. Damodaran provides a simple lookup table for large firms with more than $5 billion in market capitalization and another for smaller firms. Here they are ...

Large Firms	Small Firms	Rating
  > 8.50	 > 12.50 	AAA
6.50 - 8.50	9.50 - 12.50	AA
5.50 - 6.50	7.50 - 9.50	A+
4.25 - 5.50	6.00 - 7.50	A
3.00 - 4.25	4.50 - 6.00	A-
2.50 - 3.00	4.00 - 4.50	BBB
2.25 - 2.50	3.50 - 4.00	BB+
2.00 - 2.25	3.00 - 3.50	BB
1.75 - 2.00	2.25 - 3.00	B+
1.50 - 1.75	2.00 - 2.50	B
1.25 - 1.50	1.50 - 2.00	B-
0.80 - 1.25	1.25 - 1.50	CCC
0.65 - 0.80	0.80 - 1.25	CC
0.20 - 0.65	0.50 - 0.80	C
  < 0.20	  < 0.5 0	D


The method obviously isn't perfect but it does provide an interesting shortcut for some firms.


12/05/2008   9:32 PM EST   Permlink   save & shareDebt



 
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