Is there value in comparing companies from different sectors by using the debt-to-equity ratio?

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.

Because some industries tend to use more debt financing than others, it generally is not helpful to compare the debt-to-equity ratio of companies from different sectors. A company in the industrial goods sector, for example, is likely to have a much higher debt-to-equity ratio than a company in the basic materials sector. Average debt-to-equity ratios also vary within the sector by industry. In the consumer goods sector, for example, the electronic equipment industry tends to have lower debt-to-equity ratios than the beverages/soft drinks industry.

Consider a company with a debt-to-equity ratio of 50.00. In the basic materials sector, which as of June 2014 had an average debt-to-equity ratio of 44.04, this would be a bit high. But in the industrial goods sector, which had a debt-to-equity ratio of 362.27 at the same time, a ratio of 50.00 would be low. Comparing only the debt-to-equity ratios of companies from different sectors will not provide investors with an accurate picture, and other measures should be used before making any investment decisions.

RELATED FAQS

  1. What is the Double Exponential Moving Average (DEMA) formula and how is it calculated?

    Discover the equation for double exponential moving average, or DEMA, and learn how it is calculated for a better understanding ...
  2. What is a good interest coverage ratio?

    Learn the importance of the interest coverage ratio, one of the primary debt ratios analysts use to evaluate a company's ...
  3. What is a bad interest coverage ratio?

    Understand how interest coverage ratio is calculated and what it signifies, and learn what market analysts consider to be ...
  4. What is a good gearing ratio?

    Understand the meaning of the gearing ratio, how it is calculated, the definition of high and low gearing, and how they reflect ...
RELATED TERMS
  1. Debt/Equity Ratio

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

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

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

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

    A performance measure used to evaluate the efficiency of an investment ...
  6. Working Capital

    This ratio indicates whether a company has enough short term ...

You May Also Like

Related Articles
  1. Active Trading

    5 Must-Have Metrics For Value Investors ...

  2. Fundamental Analysis

    Earnings Quality, the Facebook Example

  3. Trading Strategies

    Not All Online Trading Brokers Are Created ...

  4. Trading Strategies

    Novice Trading Strategies

  5. Investing Basics

    How To Calculate Goodwill

Trading Center