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 formula for calculating compound annual growth rate (CAGR) in Excel?

    The concept of CAGR is relatively straightforward and requires only three primary inputs: an investments beginning value, ...
  2. What is the formula for calculating the debt-to-equity ratio?

    Find out how to use this fundamental financial ratio to help assess a company's performance.
  3. What are some common traits of undervalued stocks?

    There are a few basic factors found in companies that are worth more than their current stock price.
  4. What are the best indicators for evaluating technology stocks?

    Technology stocks are often some of the most discussed stocks on the news. How can investors spot the company that will roll ...
RELATED TERMS
  1. Earnings Per Share - EPS

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

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

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

    1. The paying off of debt in regular installments over a period ...
  5. Net Present Value - NPV

    The difference between the present value of cash inflows and ...
  6. Total Debt-to-Capitalization Ratio

    An indicator that measures the total amount of debt in a company’s ...
comments powered by Disqus
Related Articles
  1. Texas Ratio Rounds Up Bank Failures
    Personal Finance

    Texas Ratio Rounds Up Bank Failures

  2. 12 Things You Need To Know About Financial ...
    Investing Basics

    12 Things You Need To Know About Financial ...

  3. Valuing Firms Using Present Value Of ...
    Fundamental Analysis

    Valuing Firms Using Present Value Of ...

  4. How to Value Companies With Negative ...
    Fundamental Analysis

    How to Value Companies With Negative ...

  5. Decoding DuPont Analysis
    Fundamental Analysis

    Decoding DuPont Analysis

Trading Center