If you’re looking to directly invest in a company by buying its stocks or indirectly via mutual funds, you should know how to calculate its debt-to-equity ratio. This simple yet powerful metric can be an effective guide in deciding whether to invest in the company or not.
The D/E ratio is the proportion of a company's total debt versus the shareholder’s equity. Investors and analysts use the D/E ratio as an essential financial measure to evaluate a company's financial health, risk profile, and potential for investment. A high debt-to-equity ratio implies that a company has more debt than equity assets and may be a more risky investment prospect than one with low debts and higher equities.
The two main inputs for calculating the D/E ratio are the company’s total shareholder’s equity (the denominator) and the total debt liabilities (the numerator). Once you have these in place, then simply divide the debt by the equity to arrive at the D/E ratio. Would you like to know how to calculate the debt-to-equity ratio from a balance sheet? Here’s how you can do so using this sample balance sheet.
The next question would be? Is 1.02 a good ratio? Well, according to most experts, a D/E ratio between 1.5 to 2.5 is considered healthy. Anything lower is good as it shows that the company’s equity is almost equal to its debt, which, in turn, means that the company will not find it difficult to repay its obligations and continue to function the way it has been. As an investor, this is a promising sign for you as it can be deemed a low-risk investment.
Now you know how to calculate the debt-to-equity ratio with an example and can use this information as part of your own research while selecting stocks or funds to invest in. Do note, though, while the D/E ratio is a useful tool to assess the company’s financial leverage and risks associated, it should not be used without context. The industry the company operates in, the market it sells in, and many other factors need to be considered as well. As a good practice, you should first see the industry average of the D/E ratio and use that as the benchmark to make comparisons. Moreover, you should carefully evaluate the other financial metrics as well before making an informed investment decision.
Whether you wish to invest in the Indian stock exchange or trade in US stocks, the underlying principle for the D/E ratio remains the same. If you’re looking to get exposure to the US market, then consider Fi. Fi enables you to invest in top US companies — at industry-best forex rates. So you can own shares in Apple, Tesla, Microsoft, and so on! With an intuitive user interface, Fi simplifies the world of US Stocks. Besides in-app explainers, novice investors can use Curated Collections (like All-Time Favourites) to make decisions. Seasoned investors can dive deeper, apply many filters (like Stock Price) & pick from a wide range of international options. What's more, on Fi, you can buy US Stocks instantly with zero brokerage fees.
The debt-to-equity ratio (D/E ratio) is an indicator of the company’s ability to repay its outstanding liabilities. A low D/E percentage, typically, means that the company is financially stable and can repay its debts without any insolvency related issues. These companies are, usually, preferred by investors to invest in.
The debt-to-capital ratio is another measure of the company’s financial status. This is derived by dividing the company's total debt by its total capital. The total capital is the sum of all debt and equity of the company. So the formula is total debt / (total debt + total equity). A high ratio indicates that a substantial portion of the company’s financial backing is from debt instruments, making it a risky investment proposition.
The debt-to-asset ratio is a measure of the company’s assets financed by lenders. It is expressed as a percentage with a lower value indicating lower debt and lesser financial risk of investment. The formula is total liabilities/total assets. Liabilities include current and long-term ones, while assets include current, fixed, and long-term assets.
