Debt/Equity Ratio

AAA

DEFINITION of 'Debt/Equity Ratio'

A measure of a company's financial leverage calculated by dividing its total liabilities by stockholders' equity. It indicates what proportion of equity and debt the company is using to finance its assets.

 

Debt/Equity Ratio

Note: Sometimes only interest-bearing, long-term debt is used instead of total liabilities in the calculation.

Also known as the Personal Debt/Equity Ratio, this ratio can be applied to personal financial statements as well as corporate ones.

INVESTOPEDIA EXPLAINS 'Debt/Equity Ratio'

A high debt/equity ratio generally means that a company has been aggressive in financing its growth with debt. This can result in volatile earnings as a result of the additional interest expense.

If a lot of debt is used to finance increased operations (high debt to equity), the company could potentially generate more earnings than it would have without this outside financing. If this were to increase earnings by a greater amount than the debt cost (interest), then the shareholders benefit as more earnings are being spread among the same amount of shareholders. However, the cost of this debt financing may outweigh the return that the company generates on the debt through investment and business activities and become too much for the company to handle. This can lead to bankruptcy, which would leave shareholders with nothing.

The debt/equity ratio also depends on the industry in which the company operates. For example, capital-intensive industries such as auto manufacturing tend to have a debt/equity ratio above 2, while personal computer companies have a debt/equity of under 0.5.

To learn how D/E ratios can help value investors, check out our tutorial on Stock-Picking Strategies: Value Investing.

VIDEO

RELATED TERMS
  1. Asset Valuation Review (AVR)

    A process that establishes an estimate of the value of a failed ...
  2. Return On Equity - ROE

    The amount of net income returned as a percentage of shareholders ...
  3. Solvency Ratio

    One of many ratios used to measure a company's ability to meet ...
  4. Debt Ratio

    A financial ratio that measures the extent of a company’s or ...
  5. Long/Short Equity

    An investing strategy of taking long positions in stocks that ...
  6. Total Liabilities

    The aggregate of all debts an individual or company is liable ...
Related Articles
  1. Fundamental Analysis

    How do I calculate the debt-to-equity ratio in Excel?

    Understand the basics of the debt to equity ratio, how it is interpreted as a measure of financial stability and how it is calculated in Microsoft Excel.
  2. Options & Futures

    What is the average debt/equity ratio of companies in the forest products sector?

    Calculating a company's debt to equity ratio is beneficial to investors when analyzing a company's liquidity and overall financial stability.
  3. Fundamental Analysis

    What is the difference between a capital gearing ratio and a net gearing ratio?

    Understand the definition of gearing in the finance industry, the difference between net gearing and capital gearing ratios and how they are interpreted.
  4. Investing Basics

    Will Corporate Debt Drag Your Stock Down?

    Borrowed funds can mean a leg up for companies or the boot for investors. Find out how to tell the difference.
  5. Investing Basics

    What Is Private Equity?

    This investment vehicle attracts wealthy investors to increase the value of portfolio companies.
  6. Fundamental Analysis

    Ratio Analysis Tutorial

    If you don't know how to evaluate a company's present performance and its possible future performance, you need to learn how to analyze ratios.
  7. Fundamental Analysis

    Balance Sheet: Analyzing Owners' Equity

    Analyzing owners’ equity is an important analytics tool, but it should be done in the context of other tools such as analyzing the assets and liabilities on the balance sheet.
  8. Investing Basics

    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.
  9. Personal Finance

    Spotting Companies In Financial Distress

    What are the warning signs that a company is struggling - or worse, sinking - financially? Read on to find out.
  10. Bonds & Fixed Income

    Evaluating A Company's Capital Structure

    Learn to use the composition of debt and equity to evaluate balance sheet strength.

You May Also Like

Hot Definitions
  1. Prospectus

    A formal legal document, which is required by and filed with the Securities and Exchange Commission, that provides details ...
  2. Treasury Bond - T-Bond

    A marketable, fixed-interest U.S. government debt security with a maturity of more than 10 years. Treasury bonds make interest ...
  3. Weight Of Ice, Snow Or Sleet Insurance

    Financial protection against damage caused to property by winter weather specifically, damage caused if a roof caves in because ...
  4. Weather Insurance

    A type of protection against a financial loss that may be incurred because of rain, snow, storms, wind, fog, undesirable ...
  5. Portfolio Turnover

    A measure of how frequently assets within a fund are bought and sold by the managers. Portfolio turnover is calculated by ...
  6. Commercial Paper

    An unsecured, short-term debt instrument issued by a corporation, typically for the financing of accounts receivable, inventories ...
Trading Center