Accounting Ratios

Assets/Equity (x)

Assets/equity is a measure of leverage: the higher the ratio, the higher leverage is. In some ways, it is the purest measure of leverage in that it incorporates working capital. A number of companies disguise debt as a working capital liability which gets excluded from traditional leverage measures, for example, through extended payables. This measure has some limitations in that some companies or markets will generate higher returns than others and so are able to command higher leverage.

We penalise companies with a high and/or rising assets/equity ratio relative to industry peers. We think that returns are dictated more by the industry that a company operates in as opposed to the country that it is domiciled in. As such, we compare a company’s leverage to its GICS industry. As Figure 57 shows, electric utility and construction sectors are the most highly leveraged while pharmaceutical and software companies the least.

Our accounting screen is set to trigger a red flag when assets/equity exceeds the 80th percentile relative to our global sample, and/or when there is an abnormally large increase relative to the normal rate of change amongst industry peers over one and three years. This latter red flag is triggered when the increase in assets/equity exceeds the 80th percentile relative to the change experienced by the global sample between 2010 and 2015.

57