The 1 Statistic Every Investor Should Be Watching Right Now

Before you go ahead thinking passive-income stocks or growth stocks like tech will suddenly turn around, consider this ratio.

| More on:
Man holding magnifying glass over a document

Image source: Getty Images.

You’re reading a free article with opinions that may differ from The Motley Fool’s premium investing services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn more

Passive-income stocks seem to be the theme of the year in 2022. That comes from two years of solid growth that, frankly, it seems investors aren’t prepared to part with. But changing over to dividend stocks doesn’t mean you’re letting go of risk.

The problem with passive-income stocks

The thing with passive-income stocks that give you high yields is that they can dish out dividends but lose income in the meantime. While this might be good for now, it could mean that these companies need to tighten their purse strings in the near future should a recession happen.

Take Suncor Energy (TSX:SU)(NYSE:SU) for example. Suncor stock used to be a prime passive-income stock. Then the pandemic hit, and the company sliced its dividend in half. This came after several years of poor performance in the oil and gas sector. So, while dividends look great, they can all go away.

Instead of eying up passive income through dividend yields, eye stability through this other statistic.

Debt to equity

The debt-to-equity (D/E) ratio is a great way to find out if a company will remain stable during a recession. It’s used to look at a company’s financial leverage, dividing a companies total debt by its shareholder equity. This will help you understand how much of the company is funded by debt, and whether outstanding equity could cover those outstanding debts in a downturn.

Clearly, investors want to find a company with a low D/E ratio. Ideally, you want something under one. This means for every $1 of equity, it would cover $1 of debt. Then the reverse is true. If you find higher D/E ratios, this suggests a stock is higher risk.

And this can be the case for companies and industries you would think are low risk! In the case of Suncor stock, it has a D/E of 1.17. That could mean should a crash come, they’re due to sink fast.

Something to consider

While the D/E ratio isn’t a be all, end all, it’s a great tool in your arsenal during a market correction. You want companies that can cover costs should a fall happen. The D/E ratio tells you that, straight up. And while it doesn’t mean that every stock will fall, it can tell you how much these companies are willing to take on when it comes to risk.

Suncor stock isn’t actually that bad, but a lot of this may have to do with the stock cutting its dividend to keep cash on hand. That’s a good thing. Compare that to tech stocks that have a far higher D/E ratio, like Lightspeed Commerce at six or Shopify at 11.84.

Bottom line, make sure to do your homework. Understand that those passive-income stocks could suddenly need that income should a recession happen. And that would mean all the work you did and all that investment would suddenly and shockingly go away.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Amy Legate-Wolfe has positions in Lightspeed Commerce and Shopify. The Motley Fool has positions in and recommends Shopify. The Motley Fool recommends Lightspeed Commerce.

More on Investing

Target. Stand out from the crowd
Energy Stocks

3 Oversold TSX Stocks I’d Buy in Bulk

Recession fears impact oil prices, although three oversold stocks should remain resilient and generate substantial free funds flow throughout 2022.

Read more »

Stocks for Beginners

New Investors: 3 Top Dividend Stocks to Start a Simple Portfolio

These quality dividend stocks are worthy for new investors to consider for a simple passive-income portfolio.

Read more »

Dollar symbol and Canadian flag on keyboard
Tech Stocks

3 Top Canadian Growth Stocks to Buy in July

Here are three growth stocks you might want to add to your buy list in July.

Read more »

edit Four girl friends withdrawing money from credit card at ATM
Bank Stocks

CIBC Stock Could Be a Top TFSA Buy for a Rocky 2nd Half of 2022

CIBC (TSX:CM)(NYSE:CM) stock is a great dividend top pick to stash in a TFSA after the first-half market correction.

Read more »

exchange-traded funds
Dividend Stocks

2 Dividend ETFs With Significant Exposure to the TSX’s Top 2 Sectors

Two dividend ETFs offer ideal diversification because of their exposure to the TSX’s two strongest sectors.

Read more »

sale discount best price

RRSP Investors: Top Stock Pick on Sale After the Stock Market Correction

Quebecor (TSX:QBR.B) looks like a terrific dividend stock for RRSP investors to buy, as recession risks rise amid a market…

Read more »

edit Colleagues chat over ketchup chips

The Alternative Way to Look at Any Recession

Market down? Instead of losses, look for potential gains. This alternative way to look at any recession exposes a market…

Read more »

Arrow descending on a graph
Energy Stocks

Why Did Oil Stocks Crash so Suddenly?

Oil stocks like Cenovus Energy (TSX:CVE)(NYSE:CVE) crashed dramatically last week. Here's why.

Read more »