How to Calculate and Interpret the Debt-to-Equity Ratio

By Stock Research Pro • December 9th, 2008

The debt-to-equity ratio measures the relative proportion of equity and debt used to finance a company’s assets. The ratio provides an indication of the relationship between the capital contributed by creditors and that contributed by shareholders. A high ratio typically would demonstrate that the company has aggressively financed its growth through debt. The resulting interest expense can have a detrimental effect on earnings. The ratio also indicates the extent to which shareholders’ equity can fulfill the company’s obligations to creditors if liquidated.

How to Calculate the Debt-to-Equity Ratio

The D/E measure is commonly used by investors. The formula for the calculation is:

Debt-to-Equity = Total Debt / Shareholder’s Equity

If the ratio is greater than 1, the majority of the company’s assets are financed through debt. If the ratio is less than 1, its assets are primarily financed through equity.

To gather the data you will need, go to Yahoo! Finance. Enter the stock symbol in the Get Quotes box. On the lower left-hand side, click on the Balance Sheet.

Expansion Through Debt

By comparing a company’s total debt to owner’s equity, the ratio measures how much money a company might safely borrow over long periods of time. If large amounts of debt are used to finance growth (resulting in a high D/E ratio), the company aims to generate increased earnings through these expanded operations. Because the cost of borrowing is lower than the cost of equity, using leverage to finance expansion will normally increase returns to shareholders. As long as the increased earnings exceed the interest on the debt, the shareholders will benefit.

The Problem with Overusing Leverage

Overusing leverage leaves the company at risk as the cost of financing this borrowing can outweigh the return provided by the expansion. The more debt a company has outstanding, the more its earnings must go to making the interest payments.

Typical Ratios

The proper debt-to-equity ratio depends on the company’s industry. Capital-intensive industries (such as manufacturing) tend to see ratios above 2, while those companies in less capital-intensive industries typically carry a ratio of under 0.5. The normal measure for the ratio can change over time depending upon a variety of economic and social factors.

More about the debt-to-equity ratio


The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax advisor.

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