I was fishing a couple of weeks ago with two bankers who have seen numerous booms and busts in the economy. They recalled being young bankers starting out in the industry. They were being mentored by an experience banker. One day this banker turned to one of the young bankers. He said, “J., leverage is a wonderful thing….. when you are making money!”
That phrase says it all! People forgot the two edged sword of leverage. Now that the economy is down people are rethinking the use of leverage.
So how much leverage should a company have? Twenty years ago a debt to equity ratio of 2 to 1 was considered conservative and 3 to 1 was aggressive. For the past 10 years those ratios moved to 3 to 1 being the norm and 4 to 1 being aggressive. I predict that we will move back to the more conservative ratios, if we haven’t already done so.