Some investors continue to make this Ford mistake

Metrics and reports can be great. They take complicated pieces of information and put them into a form that allows you to make comparisons between competitors or industries. They can give you valuable information about the company’s performance and whether management is improving certain aspects of the business. But they can also give you the wrong idea if you don’t have the proper context or understanding. I recently ran into a misunderstanding about Ford Motor Companyhis (NYSE:F) The debt-to-equity ratio — here’s what it was and what you can learn from it.

What happened?

I recently came across an article that said something to the effect of, “Ford is using its extended debt to improve its yield. It has a shocking debt to equity ratio of 3.46”. While this number is technically correct, the analysis is unacceptably flawed.

To begin, let’s better explain the debt-to-equity ratio and why Ford’s entries need to be adjusted. The debt-to-equity (D/E) ratio measures a company’s financial leverage and is calculated by dividing total debt by equity.

The D/E ratio can be used to assess a company’s reliance on debt and is best used in comparison within an industry, as results can trend differently across industries. A higher D/E ratio suggests that a company is taking on more risk by having more debt, but it can work the other way around if a company has a low D/E and has more to gain by taking on debt and investing in business growth.

How to adjust

Ford’s D/E ratio of 3.46 brings in Ford’s total liabilities, which includes debt under Ford Credit, Ford’s finance arm. Before we go any further, let’s sort out the Ford Credit contribution.

Ford Credit takes on massive, bank-like debt and offers consumer loans and leases and supports dealership renovations, among other things. In essence, Ford Credit is taking on massive debt, but turning it into a very profitable business. Ford Credit is often more profitable than any of Ford’s regions outside of North America.

Now let’s modify this ratio to better see the difference between debt including Ford Credit and without it. Let’s just use total long-term debt, auto debt, and second-quarter equity.

Using only long-term debt leaves us with a formula of $100.3 billion divided by $43.6 billion, or a D/E of 2.3 times. Consider anything over 2 entering dangerous territory in many industries. One could look at some metrics and immediately conclude that Ford has too much debt and too much risk.

The story continues

However, when you strip out the Ford Credit debt — which again is a big plus for the company’s bottom line, not a drag — and use just the auto debt, the ratio shrinks to a much more reasonable 0.42 times. This is a major difference in how you perceive Ford and its values ​​based solely on understanding Ford’s core business and how it overlaps with Ford Credit.

What does it all mean?

This just serves as a reminder that you should always check the numbers and do your own research. And while metrics are incredibly useful, they also require context and understanding. Ford Credit is an extremely important entity to Ford and its underlying businesses, and because of the way it operates, its debt should not be included in certain installments.

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Daniel Miller holds positions in Ford Motor Company. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

Some investors keep making this Ford mistake was originally published by The Motley Fool