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.

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