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How to pick the next ASX stock to do a COVID-19 emergency capital raising

The ASX is topping its global peers when it comes to capital raisings during this trying COVID-19 market shakeup.

The amount of cash that investors have tipped into ASX share have exceeded those in London, New York and Hong Kong, according to Dealogic figures reported in the Australian Financial Review.

Even as the S&P/ASX 200 Index (Index:^AXJO) shows signs of a strong recovery from the lows of the coronavirus bear market, we may not have seen the end of the capital raising run!

If anything, improving share prices may tempt more ASX companies to come a knocking for extra capital to tide them through the looming recession.

ASX is the cap raising capital

The Dealogic data recorded 71 ASX companies going cap in hand to shareholders to raise $7.9 billion as of last Friday. This significantly exceeds the $4.8 billion raised on the London Stock Exchange, the $2.8 billion on the NYSE and the $119 million in Hong Kong.

The ASX also left the NASDAQ and New Zealand Stock Exchange in the dust.

Australians are a generous bunch! Some of the companies we helped include some of the most badly affected by the coronavirus. Examples are Webjet Limited (ASX: WEB), Oil Search Limited (ASX: OSH) and Southern Cross Media Group Ltd (ASX: SXL).

Tell-tale signs

Holding cum-capital raise stocks can be a value damaging affair, particularly if they have to sell new shares at a huge discount to drum up support. This is why it can pay to screen your portfolio for such potential candidates.

There are a few things to know that can help with this exercise. One tell-tale sign is a stock that is underperforming against its peers without an obvious reason.

The other is the level of debt a company holds. This is usually the biggest reason for a company to do an emergency capital raise and it contributed to the collapse of Virgin Australia Holdings Ltd (ASX: VAH).

Debt ratios explained

Here is where some investors get confused by the different terms used to check if the debt load is getting too great. If you hear that a company is over-geared or over-leveraged, you should ask in what way as there are several measures to determine this.

Below is a list and explanation of a few of the key measures most commonly used.

Net Debt-to-Equity (ND/Equity): This is often the most commonly used ratio and all the figures can be found on the balance sheet. It adds up all the debt (usually listed as “interest bearing liabilities”), deducts the cash held, and divides the number by the total equity. The smaller the ratio, the safer the company is from debt. There isn’t a magic number to look for but you will want to compare this with other similar companies, particularly if the ratio is over 1.

Quick Ratio: This is another simple one to calculate. It’s used to see if a company can meet its short-term debt obligations. It takes the company’s liquid assets (e.g. cash, accounts receivable) and divides it by its current liabilities. Again, all the information you need to work out the quick ratio is on the balance sheet.

Interest Cover: This ratio tells you if the company is generating enough profits to cover its repayment obligations. For this, you need to take the earnings before interest and tax and divide it by the interest expense. The interest expense is not the debt on the balance sheet but the repayments listed in the cash flow statement.

Foolish takeaway

It is important to remember that no one measure can give you a full picture. You need to look at other factors and ratios to make a more definitive decision.

But these simple checks can help give you an early signal that a desperate cap raise is on the cards!

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Motley Fool contributor Brendon Lau owns shares of Webjet Ltd. Connect with him on Twitter @brenlau.

The Motley Fool Australia owns shares of and has recommended Webjet Ltd. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.