We penalise companies which have low and falling interest cover as it suggests a weak and deteriorating financial position. As Figure 87 shows, asset-heavy industries, such as electric utilities, real estate and oil & gas, have lower interest cover (3-5x) than asset-light industries, such as software and IT. Asset heavy industries require higher levels of leverage in order to finance long investment lead times and are rewarded with stable revenues which justify lower interest cover. Meanwhile, asset light industries require lower levels of capex and debt financing.
Our accounting screen is set to trigger a red flag when interest cover is in the lowest 20th percentile relative to GICS industry peers (i.e. it is very low), and/or when there is an abnormally large deterioration relative to the normal rate of change amongst industry peers over one and three years. This latter red flag is triggered when the deterioration in interest cover is in the 20th percentile relative to the change experienced by industry peers between 2010 and 2015. For scoring purposes, we reverse the percentile.