How to Analyze Debt and Valuation of a Company?

Introduction

Every successful investor, from Warren Buffett to Rakesh Jhunjhunwala, has one thing in common: they understand a company’s financials before investing.

In India, where more than 70 lakh new investors joined the stock market in 2024 alone, the biggest mistake beginners make is buying stocks without analysing debt and valuation. A company may have strong revenues and popular products, but if its debt is high or valuation is inflated, it can quickly turn into a risky bet.

This guide will help you learn how to analyse debt and valuation step-by-step, using practical metrics, formulas, and examples, even if you don’t have a finance background.

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Why Analysing Debt and Valuation Matters

Debt and valuation are two sides of the same coin when evaluating a company:

• Debt analysis tells you how much risk a company carries.
• Valuation analysis tells you if the stock is overpriced or undervalued.

Together, they help you answer the two most important investment questions:

1. Can this company handle its financial obligations?
2. Am I paying a fair price for its stock?

A strong company has a manageable debt load and reasonable valuation, giving investors both stability and growth potential.

Analysing Debt: Understanding a Company’s Leverage

Debt isn’t always bad. Many companies use it strategically to expand operations, enter new markets, or invest in technology. The key is how effectively they manage it.

Here’s how you can evaluate it step by step 👇

• Debt Ratios

For a business, debt (leverage) is like a double-edged sword. They can expand their business and improve their sales with the help of loan funds. However, if not used wisely, the interest paid on these loans can eat away at a company’s bottom line. It can also lead to a tight squeeze on cash for future operations. Leverage ratios can be classified as follows:

1. Debt to Equity Ratio 
2. Debt to Asset Ratio 
3. Financial Leverage 
4. Interest Coverage Ratio

1. Debt to Equity Ratio 

Equity is the value that belongs to the shareholders of the company. It is calculated by subtracting liabilities from the value of assets. The debt-to-equity ratio tells us how much debt a company currently has to its equity. We can find a company’s total equity in its balance sheet. By adding up the short-term debt and the long-term debt, we get the debt.

Debt/equity ratio = total debt/total equity

2. Debt to Asset Ratio

In this ratio, we replace the total equity of the previous ratio with the total assets of the company. By converting the results into a percentage, we can analyze the proportion of a company’s assets secured by debt.

Debt to Asset = Total Debt / Total Assets

3. Financial Leverage

Financial leverage adds another dimension to a company’s debt analysis. Although the formula does not include debt, it appears that assets are present for every unit of equity. The formula is:

Leverage = Total assets / Total equity

4. Interest Coverage Ratio

The interest coverage ratio tells us how much a business can earn relative to paying interest. It is also known as the debt service ratio. 

Interest Coverage Ratio = Earnings Before Interest and Taxes (EBIT) / Financing Expense

EBIT is calculated by adding finance costs (listed as an expense) to pre-tax profit (PBT).

Analysing Valuation: Is the Stock Fairly Priced?

Once debt health is clear, the next step is valuation, figuring out if a stock is undervalued, fairly priced, or overvalued.

Here’s a practical framework used by analysts and investors:

• Valuation Ratios

As stock market investors, it is ideal to buy stock in a company when it has a cheaper valuation. Valuation is the process of determining the true value of an asset or business. For example, real estate prices for a particular plot of land increase when there is an announcement of a new urban area or a tourism project. People who buy plots earlier at a cheaper price tend to take advantage of higher property valuations. Similarly, investors can measure the value of each stock they invest in.

• Price/Earnings Ratio (P/E)

The price-to-earnings ratio gives you an insight into how much stock market participants are willing to pay for the stock for every Rs 1 in profit the company generates. EPS can be easily calculated by dividing a company’s net profit by the total number of shares. Each industry/sector has a different valuation margin. Therefore, a standard P/E range cannot be established for all stocks.

Price/earnings ratio = current market price/earnings per share (EPS)

• Price to Sales (P/S) Ratio

We have used earnings per share (EPS) to calculate the P/E ratio. However, EPS can be affected by factors such as changes in the tax system, new accounting rules, liquidity. one-time calculation, etc. To overcome this, we can look at the total revenue of a company to find out its valuation.

Price-to-sales ratio (P/S) = current market price / sales per share

• Price/Book(P/B) Ratio

Assume a company goes out of business after liquidating its assets and all liabilities. Any final funds remaining in the company must be distributed to its investors. This value is called the book value of a business. The sum of equity and cash reserves on a company’s balance sheet is its carrying amount. Divide the book value by the total number of shares to get the book value per share.

Price-to-book ratio = current market price / book value per share

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• EV/EBITDA Ratio

This metric considers both debt and equity, giving a clearer view of total valuation. It is used to consider the companies value to its earnings before interest, taxes, depreciation, and amortization.

Formula:

EV/EBITDA = (Market Cap + Debt – Cash) / EBITDA

Interpretation:

• EV/EBITDA < 10: Reasonably valued
• > 15: Expensive

Investors prefer this ratio because it accounts for debt impact, unlike P/E.

A Step‑by‑Step Framework to Analyse Debt & Valuation

Here’s a practical workflow you can follow.

1: Understand the business

• What industry is the company in? Growth or mature?
• What are the business drivers and risks?
• How capital‑intensive is the business (higher capital intensity → often higher debt).
  Context matters.

2: Collect financials

• Get the latest 3‑5 years of balance sheet, income statement, cash‑flow (from Indian filings or financial portals).
• Record: debt (short‑term + long‑term), equity, cash & equivalents, EBIT/EBITDA, operating cash‑flow, interest expense.

3: Calculate key ratios

• D/E ratio
• Debt/EBITDA
• Interest coverage
• Cash‑flow to debt
  Interpret: are they trending better or worse? Compare to peer industry.

4: Qualitative checks on debt

• What is the debt maturity profile? Are most borrowings short‑term (risky)?
• Are there large off‑balance sheet items or contingent liabilities (e.g., legal cases, guarantees)?
• Does management’s commentary (in annual report) indicate expected refinancing risk or rising interest cost?
• Are interest rates rising (especially in India) and could increase cost of debt?

5: Valuation analysis

• Compute EV = Market cap + Debt – Cash.
• Determine peer multiple (EV/EBITDA) or choose to run DCF if you’re comfortable.
• Apply the multiple to company’s EBITDA, derive implied EV, then implied equity value and target price.
• Check for reasonableness: does target price signal high return vs current price? If not, maybe risk is high.
• Adjust for debt risk: if debt is heavy and interest cost high, shrink the margin of safety.

6: Make investment judgment

• If debt metrics are strong (low D/E, high coverage) and valuation is attractive → good investment candidate.
• If debt metrics are weak (high leverage, low coverage) but valuation is cheap — still risk is high, may be speculative.
• If debt metrics are weak and valuation is expensive — avoid.
• Always factor in your investing horizon, risk appetite, and Indian market environment (interest rates, economy, regulatory risk).

7: Monitor regularly

• Review these metrics each quarter; debt dynamics can change swiftly.
• Watch for rising interest expense, changes in debt maturity, sudden large borrowings or guarantees.
• If your investment thesis changes (e.g., debt risk grows), re‑evaluate.

Combining Debt and Valuation for Smart Investing

Analysing both together gives you the complete picture:

💡 Pro Tip: Always cross-check financial ratios with management commentary in annual reports and investor presentations. Numbers tell you what happened; management tells you why.

Tools for Debt and Valuation Analysis

You don’t need fancy software to begin. Here are some reliable tools used by Indian investors:

• Screener.in – Ratio analysis, financial trends, peer comparison.
• NSE India – Stock data, financial statements, and valuations.
• TradingView – Charting plus financial indicators.

How Entri’s Stock Market Course Can Help You Master Company Analysis

If you’re serious about learning how to analyse stocks like a professional, the Entri Stock Market Course is designed exactly for you.

Here’s what you’ll learn:

• 📈 Financial statements (Balance Sheet, P&L, Cash Flow)
• 💰 Debt Ratios, Valuation Metrics, Cash Flows
• 🧮 P/E, P/B, EV/EBITDA like an analyst
• 🤖 AI-driven tools to find undervalued stocks
• 💼 Case studies and market simulations

Whether you’re a student, working professional or beginner investor, Entri gives you the tools and skills to evaluate companies rationally, not emotionally.

Key Takeaways

✅ Debt analysis helps to measure financial stability and repayment capacity.
✅ Valuation metrics tells you if the stock is overpriced or undervalued.
✅ Always analyse both together for a balanced decision.
✅ Compare with industry averages, not in isolation.
✅ Look beyond numbers, understand business models and management intent.
✅ Learn advanced analysis through Entri’s Stock Market Course to get real-world investing skills.