Companies with high leverage ratios stand to make good profits in booming economic times, as they can afford to maximize their output to meet budding demand. However, they are more vulnerable during recessions when sales typically slow and can be insufficient to cover interest expenses. During periods of slow or negative revenue growth, massive interest expenses can also lead to volatile earnings results from one quarter to the next, making the stock less popular among investors.

The chart below highlights 4 of the 10 companies we’ve chosen to highlight whose long-term debt/equity ratios have climbed substantially in the last year and are high relative to their historical average.

The full list of non-financial “dangerous stocks” is shown below.

Readers must note that we chose these stocks because they also received sell recommendations by our Ranking System for the month of April.

The chart below shows that the net percentage of banks tightening lending standards on commercial and industrial loans remains high. Despite the government’s efforts to spur lending activity, it is doubtful that this serious problem will be corrected immediately. Thus in addition to high earnings volatility and the increased threat of not being able to cover interest charges when sales are weakening, companies who depend heavily on debt also face operational risk as it is still difficult to access capital to fund day-to-day operations. As a result, stay clear of these stocks until they lower their operating leverage or economic conditions improve.

*Source: The Federal Reserve

Happy Trading

Disclosure: No positions at the time of writing.

Tags: APD, bank lending standards, BNI, CAT, CME, COP, debt/equity ratio, EPD, ETR, HPQ, IBM, MAR, sell

This entry was posted on Thursday, April 2nd, 2009 at 9:41 PM and is filed under Investment Ideas. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.