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.

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