Gearing
Gearing is a term used to describe the process of borrowing money for investment purposes in the expectation that the returns on the investments purchased using the borrowings exceeds the costs of those borrowings. It illustrates the effect that current prior charges may have on the value of the shareholder funds if the total assets were to rise or fall. A figure of 115 means that the shareholder funds are 15% geared and indicates the extra amount by which the shareholder funds would rise or fall if the total assets were to rise or fall. A figure of 100 means there is no gearing.
The gearing ratio for AIC Statistics purposes is expressed as a ratio of total assets to shareholders’ funds multiplied by 100. Generally, the higher the gearing, the more sensitive an investment company’s shares will be to the movements in the value of the investment portfolio. For split capital companies, any prior ranking share classes are taken into account. The gearing figures on our website reflect traditional types of structured debt such as loans, debentures and prior ranking shares. Synthetic types of geared instruments such as contracts for difference (CFDs) are not taken into account.
The AIC publishes gross and net gearing figures. The gross gearing figure reflects the value of prior charges drawn down by a company with no adjustments for amounts held in cash/cash equivalents and the net gearing figure reflects the amount of prior charges actively invested and not held in cash/cash equivalents.
Gross gearing is calculated by dividing a company’s total assets by shareholders’ funds and net gearing by dividing total assets (less cash/cash equivalents) by shareholders’ funds. For example, if a company has 100 million of total assets and 13 million of borrowings, the shareholders’ funds would be 87 million. If the total assets were to rise or fall by 10% to 110 million or 90 million, and the borrowings were to remain the same at 13 million, the shareholders’ funds would either rise to 97 million or fall to 77 million. This represents an increase or decrease of 11.5%, which in both cases is 15% more than the 10% increase or decrease in the total assets. Therefore, the shareholders’ funds are 15% geared and the gross gearing ratio would therefore be 115.
Net gearing is calculated as described above, but the amount held in cash/cash equivalents is deducted from the total assets. Therefore, if the total assets and shareholders funds were to remain as above (100 million and 87 million, respectively) but the company held 10 million in cash/cash equivalents then the shareholders funds would be 3% geared and the net gearing ratio would therefore be 103.
