“Stronger issuers with higher credit ratings are best assessed with ratios involving funds from operations. Weaker credits with lower credit ratings are best assessed with free operating cash flow ratios.” Why?
Because a strong issuer will have no problem covering debts/expenses (in the short term), so you should use their accounting numbers, which may differ substantially from their actual cash flow. A weaker issuer is going to be more of a credit risk so you should focus on the actual cash they bring in the door and have on hand to pay liabilities, rather than focusing on any of their make-believe “paper profits”. The gist is that you wanna know if you’re going to get paid; with a “strong” issuer, the answer is “yes” in the short term, so you’d want to use their financials for other reasons (anticipate upgrade/downgrade, etc.). For a weaker issuer, you wanna see if they’ve got your physical $10, as opposed to whether their accounting shows that they should have $100,000 but they’re hitting you up for gas money. Sorry if that confused you more…my writing is getting more tangential by the day…
That makes sense. Thanks a skillion…
No worries.