First and foremost, leverage is only appropriate if the underlying business provides concrete evidence of resilience, or even more ideally, strong growth.
In addition to traditional ratios, it is therefore essential to carry out a thorough fundamental analysis of the company's business, its strategy and the competitive dynamics of the markets in which it operates.
The trap scenario is precisely the opposite - that of a company increasing its financial leverage to compensate for a business that is structurally shrinking or declining. A case in point is WarnerBros Discovery, often discussed in our columns.
If the company in question passes this first test, then the three points below deserve close attention:
Firstly, the level of debt in terms of operating profit to total enterprise value - or EV/EBIT. This ratio is more relevant than the well-known EV/EBITDA, because a company that no longer invests in its business generally sees its revenues and profits fall.
Secondly, the weighted cost of debt, bearing in mind above all that this is likely to increase as interest rates rise or as a result of the deterioration of solvency ratios - sometimes dramatically so when a scissor effect of the two phenomena occurs simultaneously.
Thirdly, the structure of the debt, i.e. its covenants, and whether it is fixed or variable - the first option being generally preferable, particularly in a context of rising interest rates. The aim was to avoid the potential "wall of debt" that would place the company in a sudden situation of insolvency.
MarketScreener tip: it makes sense to track the ROA and ROE ratios - return on assets and return on equity - over time.
When ROA falls but ROE rises, the company is typically compensating for lower operating performance by increasing its financial leverage - with all the risks this entails.
The case of BASF springs to mind.