Debt-to-Equity Ratio

Debt-to-Equity Ratio

Debt-to-equity compares what a company has borrowed against what its shareholders have in it.

The formula

D/E = Total debt / Shareholders' equity

Note that IQInvest reports this as a percentage, so a value of 78 means debt is 78% of equity, and 150 means debt is 1.5 times equity.

How IQInvest reads it

• Below 50 — conservative. Comfortably financed.
• 50-150 — moderate. Normal for most established companies.
• Above 150 — heavily geared.

Why leverage cuts both ways

Debt is not automatically bad. Borrowing at 5% to earn 15% is good business, and a company with no debt at all may simply be under-using cheap capital.

What debt does is magnify outcomes. In a good year, profits are spread across a smaller equity base and returns look excellent. In a bad year, the interest is still due whether or not the profit arrived. That is why heavily geared companies fail in recessions while their conservative competitors merely have a poor year.

Two things change the reading:

• Rising interest rates. Debt taken cheaply becomes expensive when it is refinanced.
• Industry norms. Utilities and property carry high debt against predictable, contracted cash flows. A software company with the same ratio is a different proposition entirely.

Always read this ratio next to interest coverage and the current ratio: the question is not only how much is owed, but whether the cash flow comfortably services it.

Related

• ROE is inflated by leverage, so read the two together.
• The current ratio covers short-term obligations specifically.