What is considered a high debt-to-equity ratio and what does it say about the company?

By Jean Folger AAA
A:

The debt-to-equity ratio is a measure of a company's financial leverage that relates the amount of a firms' debt financing to the amount of equity financing. It is calculated by dividing a firm's total liabilities by total shareholders' equity. What is considered a "high" debt-to-equity ratio differs depending upon the industry, because some industries tend to utilize more debt financing than others. There is no single value above which would be deemed a high debt-to-equity ratio.

The financial industry, for example, typically has a higher debt-to-equity ratio. This is due to the fact that banks and other financial institutions borrow money to lend money, which results in a higher debt-to-equity ratio. Other industries that are highly capital intensive, such as services, utilities and the industrial goods sector, also tend to have higher debt-to-equity ratios.

As a result, investors must look at a company's historical debt-to-equity ratio figures to determine if there have been significant changes that could indicate a red flag. In addition, investors must also make comparisons between other similar companies and the industry as a whole to determine if a particular firm has what could be considered a high debt-to-equity ratio.

A higher debt-to-equity ratio typically shows that a company has been aggressive in financing its growth with debt, and there may be a greater potential for financial distress if earnings do not exceed the cost of borrowed funds. 

RELATED FAQS

  1. What does a mutual fund's beta coefficient measure?

    Evaluate the risk associated with a particular mutual fund by determining its beta coefficient, which illustrates the fund's ...
  2. What are some examples of how cash flows can be manipulated or distorted?

    Read about some of the most common accounting techniques that can be used to manipulate the operating cash flow on a company's ...
  3. Where can I find the balance sheet of a country?

    Learn where to find balance sheets for different countries. Explore how different accounting standards may affect the quality ...
  4. What are some examples of industries that cannot claim cost of goods sold (COGS)?

    Discover which types of businesses are not allowed to list cost of goods sold on their income statement or claim their COGS ...
RELATED TERMS
  1. Debt/Equity Swap

    A transaction in which the obligations (debts) of a company or ...
  2. Debt/Equity Ratio

    A measure of a company's financial leverage calculated by dividing ...
  3. Best's Capital Adequacy Relativity (BCAR)

    A rating of an insurance company’s balance sheet strength. Best’s ...
  4. Deferred Tax Asset

    A deferred tax asset is an asset on a company's balance sheet ...
  5. Earnings Per Share - EPS

    The portion of a company's profit allocated to each outstanding ...
  6. Return On Investment - ROI

    A performance measure used to evaluate the efficiency of an investment ...
Related Articles
  1. The return on Assets (ROA) and return on equity (ROE) are often used metrics to measure the returns generated by a company.
    Fundamental Analysis

    How Do Tech Companies Measure ROA And ...

  2. Fundamental Analysis

    SIC Vs. NAIC -An Introduction To Industry ...

  3. Mutual Funds & ETFs

    Investing In New York City REITs

  4. Credit & Loans

    How Sallie Mae Affects Student Loans

  5. Investing Basics

    How to Use the Gearing Ratio

Trading Center