Debt Analysis: How to Judge If a Company Is Overleveraged in India
Debt Analysis: How to Judge If a Company Is Overleveraged in India
When analyzing stocks in India, investors often focus on revenue, profit, or valuation ratios. But one factor that can quietly destroy shareholder wealth is debt. A company that is overleveraged (i.e., carrying too much debt compared to its ability to repay) can face liquidity crunches, credit downgrades, and even bankruptcy.
Thank you for reading this post, don't forget to subscribe!Understanding how to do debt analysis is essential for both beginners learning fundamental analysis of stocks and seasoned investors looking for the best stocks for long-term investment in India.
Let’s break down the key metrics and red flags to judge whether a company is carrying too much debt.
1. Debt-to-Equity Ratio (D/E)
- Formula: Total Debt ÷ Shareholders’ Equity
- A high ratio (>1) means the company is financing growth largely through borrowings rather than its own funds.
- In capital-intensive sectors like infrastructure, telecom, or power, higher D/E may be normal.
- In sectors like IT or FMCG, a high D/E is a red flag.
👉 Example: Many Indian IT firms (Infosys, TCS) operate with almost zero debt, while infrastructure players like Adani Power carry high leverage.
2. Interest Coverage Ratio (ICR)
- Formula: EBIT ÷ Interest Expense
- Shows how easily a company can pay its interest from operating profits.
- ICR < 2 → Dangerous zone, indicates stress.
- Higher ICR → Safer company.
👉 Example: Companies like NTPC have strong interest coverage due to stable cash flows, while stressed firms like Suzlon once had very weak ICR.
3. Debt-to-EBITDA Ratio
- Formula: Total Debt ÷ EBITDA
- Measures how many years of operating profit would be needed to repay debt.
- <3 → Comfortable
- >5 → Overleveraged, risky.
👉 Used by credit rating agencies to evaluate solvency.
4. Free Cash Flow (FCF) vs Debt
Even if profit looks strong, companies need free cash flow to repay loans.
- Check whether FCF is consistently positive.
- If debt is rising while FCF is negative → red flag.
👉 Example: Telecom operators once reported profits but negative FCF due to heavy spectrum costs → debt piled up.
5. Short-Term vs Long-Term Debt Structure
- Heavy short-term debt can be risky if the company doesn’t generate enough working capital.
- Long-term debt with stable repayment schedules is safer.
👉 Example: Many NBFCs in India faced crises when short-term borrowings were higher than long-term lending commitments (IL&FS crisis, DHFL case).
6. Credit Ratings & Pledged Shares
- Credit Rating Agencies (CRISIL, ICRA, CARE) downgrade firms when debt becomes unmanageable.
- If promoters pledge a large portion of their shares to borrow → risky signal.
7. Sector Context Matters
- Banking, infra, power → higher debt is normal but must be supported by cash flows.
- FMCG, IT, pharma → low debt preferred.
📌 Case Study: Reliance Industries vs Yes Bank
- Reliance Industries had high debt in 2010–2016, but it used cash flows from oil & gas + raised equity in Jio to deleverage. Today, its debt is under control.
- Yes Bank faced a crisis partly because of rising NPAs and weak debt repayment capability, leading to collapse in share price.
Final Thoughts
When doing fundamental analysis of stocks, debt analysis is one of the most critical steps.
👉 Quick checklist to judge overleverage:
- D/E > 1 → Red flag (unless sector-specific).
- ICR < 2 → Cannot comfortably pay interest.
- Debt-to-EBITDA > 5 → Too much burden.
- Negative Free Cash Flow + Rising Debt → Trouble ahead.
- High promoter pledge → Stay cautious.
For stock analysis for beginners in India, the rule is simple:
💡 If debt is rising faster than profits and cash flows, avoid the stock for long-term investment.
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Disclaimer: This blog post is intended for informational purposes only and should not be considered financial advice. The financial data presented is subject to change over time, and the securities mentioned are examples only and do not constitute investment recommendations. Always conduct thorough research and consult with a qualified financial advisor before making any investment decisions.