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. Which leverage ratios are most useful for analyzing manufacturing companies?

    See which leverage ratios investors and creditors are likely to use when analyzing the debt burdens for manufacturing companies.
  2. What are the main components of the Federal Reserve's balance sheet?

    Find out which items are listed as assets and liabilities on the balance sheet of the Federal Reserve, and how to read the ...
  3. What's more important, cash flow or profits?

    Learn about the different effects that cash flow and profit have on a business so you can decide which aspect to focus on.
  4. 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 ...
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 ...
Related Articles
  1. 5 Must-Have Metrics For Value Investors ...
    Active Trading

    5 Must-Have Metrics For Value Investors ...

  2. How Do Tech Companies Measure ROA And ...
    Fundamental Analysis

    How Do Tech Companies Measure ROA And ...

  3. SIC Vs. NAIC -An Introduction To Industry ...
    Fundamental Analysis

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

  4. Investing In New York City REITs
    Mutual Funds & ETFs

    Investing In New York City REITs

  5. How Sallie Mae Affects Student Loans
    Credit & Loans

    How Sallie Mae Affects Student Loans

Trading Center