When using the D/E ratio, it is very important to consider the industry in which the company operates. Because different industries have different capital needs and growth rates, a D/E ratio value that’s common in one industry might be a red flag in another. Gearing ratios constitute a broad category of financial ratios, of which the D/E ratio is the best known.

Some industries, such as finance, utilities, and telecommunications, normally have higher leverage due to the high capital investment required. A low D/E ratio indicates a what is a favorable variance what it means for your small business decreased probability of bankruptcy if the economy takes a hit, making it more attractive to investors. However, a high D/E ratio isn’t necessarily always bad, as it sometimes indicates an efficient use of capital. Banks, for example, often have high debt-to-equity ratios since borrowing large amounts of money is standard practice and doesn’t indicate mismanagement of funds.

What is a good debt-to-equity (D/E) ratio?

A business that ignores debt financing entirely may be neglecting important growth opportunities. The benefit of debt capital is that it allows businesses to leverage a small amount of money into a much larger sum and repay it over time. This allows businesses to fund expansion projects more quickly than might otherwise be possible, theoretically increasing profits at an accelerated rate. When used to calculate a company’s financial leverage, the debt usually includes only the Long Term Debt (LTD). The composition of equity and debt and its influence on the value of the firm is much debated and also described in the Modigliani–Miller theorem.

Can a company have a negative debt-to-equity ratio?

Restoration Hardware’s cash flow from operating activities has consistently grown over the past three years, suggesting the debt is being put to work and is driving results. Additionally, the growing cash flow indicates that the company will be able to service its debt level. As an example, the furnishings company Ethan Allen (ETD) is a competitor to Restoration Hardware.

Finance

State Street Corp now owns 10,193,572 shares of the utilities provider’s stock worth $1,319,264,000 after acquiring an additional 662,569 shares during the period. Boston Partners increased its position in DTE Energy by 25.1% during the fourth quarter. Boston Partners now owns 2,899,823 shares of the utilities provider’s stock valued at $350,150,000 after acquiring an additional 582,643 shares during the last quarter. Janus Henderson Group PLC lifted its holdings in DTE Energy by 2.4% in the third quarter. Janus Henderson Group PLC now owns 2,720,265 shares of the utilities provider’s stock valued at $349,309,000 after acquiring an additional 64,880 shares during the period. Finally, Charles Schwab Investment Management Inc. grew its stake in shares of DTE Energy by 2.5% during the 4th quarter.

What is considered a good debt-to-equity ratio?

The debt-to-equity ratio is a powerful tool for financial analysis, providing insights into a company’s capital structure, financial leverage, and risk profile. Company B’s debt-to-equity ratio of 0.125 indicates that it has £0.125 of debt for every £1 of equity. This relatively low ratio suggests that Company B is not heavily leveraged and relies more on equity financing.

Case Study: Assessing Debt-to-Equity Ratios for Investment Decisions

The growing reliance on debt could eventually lead to difficulties in servicing the company’s current loan obligations. Short-term debt also increases a company’s leverage, of course, but because these liabilities must be paid in a year or less, they aren’t as risky. To obtain what is a contra asset account definition and meaning the company’s equity figure, USD1 million is subtracted from the USD2 million in assets, as this figure includes assets funded by both debt and equity. This gives an equity figure of USD1 million and a D/E ratio of 1.0, which is derived by dividing the total debt of USD1 million by the equity figure of USD1 million. Although their D/E ratios will be high, it doesn’t necessarily indicate that it is a risky business to invest in.

Debt to equity ratio in decision making

As you can see from the above example, it’s difficult to determine whether a D/E ratio is “good” without looking at it in context. To get a sense of what this means, the figure needs to be placed in context by comparing it to competing companies. Total liabilities are all of the debts the company owes to any outside entity.

• The D/E ratio indicates how reliant a company is on debt to finance its operations.
• This result indicates that XYZ Corp has $3.00 of debt for every dollar of equity.
• Generally, an ideal debt-to-equity ratio in real estate and other capital-intensive sectors is 2.33 or so, meaning you have 70% debt and 30% equity.
• It’s usually advisable not to invest in any property with a debt-to-equity ratio of 5.5 or more — a higher debt-to-equity ratio than that, and you’ll take on a greater financial risk by purchasing the property.
• Higher D/E ratios can also tend to predominate in other capital-intensive sectors heavily reliant on debt financing, such as airlines and industrials.

Over this period, their debt has increased from about $6.4 billion to $12.5 billion (2). It’s also important to note that interest rate trends over time affect borrowing decisions, as low rates make debt financing more attractive. Additional factors to take into consideration include a company’s access to capital and why they may want to use debt versus equity for financing, such as for tax incentives. For growing companies, the D/E ratio indicates how much of the company’s growth is fueled by debt, which investors can then use as a risk measurement tool. When making comparisons between companies in the same industry, a high D/E ratio indicates a heavier reliance on debt. Investors can use the D/E ratio as a risk assessment tool since a higher D/E ratio means a company relies more on debt to keep going.

Lenders and debt investors prefer lower D/E ratios as that implies there is less reliance on debt financing to fund operations – i.e. working capital i havent filed taxes in 10 years or more requirements such as the purchase of inventory. The D/E ratio can be skewed by factors like retained earnings or losses, intangible assets, and pension plan adjustments. Therefore, it’s often necessary to conduct additional analysis to accurately assess how much a company depends on debt. A steadily rising D/E ratio may make it harder for a company to obtain financing in the future.

Thus, analysts might be subjective in their interpretation and judgment, resulting in possible variations on how they classify different assets as either debt or equity. Preferred stock for example may be categorised by some as equity, while a preferred dividend may be perceived by others as debt, due to its value and limited liquidation rights. The D/E Ratio is also crucial for comparing companies within the same industry. Different industries have different capital structures and financing norms, making it essential to compare a company’s debt-to-equity ratio against industry averages and benchmarks.

• Shareholders’ equity can increase through retained earnings and additional investments from shareholders.
• Those that already have high D/E ratios are the most vulnerable to economic downturns, because declining profits then make it harder to pay back debt, which can lead to further borrowing or issues like bankruptcy.
• At first glance, Company Y’s lower debt-to-equity ratio may seem more favourable.
• Finally, if we assume that the company will not default over the next year, then debt due sooner shouldn’t be a concern.
• A steadily rising D/E ratio may make it harder for a company to obtain financing in the future.

A D/E ratio close to zero can also be a negative sign as it indicates that the business isn’t taking advantage of the potential growth it can gain from borrowing. Therefore, a “good” debt-to-equity ratio is generally about balance and relative to peers. While the D/E ratio formula only has a few steps, it’s important to know what each part means. Total liabilities are combined obligations that a company owes other parties, including both short-term ones like accounts payable and long-term ones like certain loans. Guggenheim increased their price objective on shares of DTE Energy from $139.00 to $147.00 and gave the stock a “buy” rating in a research note on Friday, March 21st. StockNews.com upgraded shares of DTE Energy from a “sell” rating to a “hold” rating in a research note on Friday, February 21st.

The debt-to-equity ratio is a financial equation that measures how much debt a company has relative to its shareholders’ equity. It can signal to investors whether the company leans more heavily on debt or equity financing. While the D/E ratio is primarily used for businesses, the concept can also be applied to personal finance to assess your own financial leverage, especially when considering loans like a mortgage or car loan. A D/E ratio of 1.5 would indicate that the company has 1.5 times more debt than equity, signaling a moderate level of financial leverage. For a mature company, a high D/E ratio can be a sign of trouble that the firm will not be able to service its debts and can eventually lead to a credit event such as default.

If a company has a negative D/E ratio, this means that it has negative shareholder equity. In most cases, this would be considered a sign of high risk and an incentive to seek bankruptcy protection. We can see below that for Q1 2024, ending Dec. 30, 2023, Apple had total liabilities of $279 billion and total shareholders’ equity of $74 billion. The long-term D/E ratio measures the proportion of a company’s long-term debt relative to its shareholders’ equity.

Investors can compare a company’s D/E ratio with the average for its industry and those of competitors to gain a sense of a company’s reliance on debt. On the other hand, the typically steady preferred dividend, par value, and liquidation rights make preferred shares look more like debt. The debt-to-equity ratio (aka the debt-equity ratio) is a metric used to evaluate a company’s financial leverage by comparing total debt to total shareholder’s equity. In other words, it measures how much debt is being used to finance the company vs. the amount of equity owned by shareholders.

While not a regular occurrence, it is possible for a company to have a negative D/E ratio, which means the company’s shareholders’ equity balance has turned negative. By contrast, higher D/E ratios imply the company’s operations depend more on debt capital – which means creditors have greater claims on the assets of the company in a liquidation scenario. That said if the D/E ratio is 1.0x, creditors and shareholders have an equal stake in the company’s assets, while a higher D/E ratio implies there is greater credit risk due to the higher relative reliance on debt.