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Author Bart Bregman

Bart Bregman

Author & Etoro expert: 9 Years of full-time trading experience. "There is no such thing as a bad trade."

Disclaimer: The information provided on this blog should not be seen as financial advice, and is only intended for entertainment and informational purposes.

A Deep Dive Into Debt-Equity Ratio

The debt-equity ratio is measured by dividing an organisation’s complete debt by its stakeholder equity. The balance sheet section of the organisations financial statement should readily provide this. It is a measure of how an organisation is funding its day to day activities, using debt or its own money.

de ratio eToro

A bit of a deep dive is usually needed to understand the true D/E ratio, as it can be skewed by factors such as intangible assets, pension adjustments, retained profits or losses etc. In some cases, analysts modify this parameter to be more insightful, it also makes it easier to compare between stocks.

What Can You Learn From D/E Ratio

Table of content

  • What Can You Learn From D/E Ratio
  • Modifications to D/E Ratio
  • Limitations of D/E Ratio
  • GENERAL RISK WARNING
  • Author & Expert Trader:

Given that it measures debt relative to the value of assets, it is often used to understand the level to which an organisation takes on debt as a means of leveraging assets. A high D/E ratio could mean that the company is taking big risks and is being aggressive in funding its growth with debt. This is a high risk vs high reward scenario – the organisation could earn more with the borrowed money or it could lose (part of) the borrowed money. It is important to comprehend the situation and the company before investing further. Also, long term assets and debts have a larger impact on the D/E ratio than short term debts and assets, this is because usually, the sum of long term debts and assets is larger. Other ratios need to be used for assessing the short term financial situation.

Modifications to D/E Ratio

A common modification to the D/E Ratio is to convert it to a long-term D/E Ratio, which helps focus on more important risks. Short-term liability is indeed part of the complete position of an organisation, but it will be cleared in a year or less. Which makes it less risky. Imagine an organisation with $1 million in short-term liabilities and $500,000 in long-term liabilities. Compare that to an organisation with $500,000 in short-term liabilities and $1 million in long-term liabilities. Both have $1.5 million in equity, meaning both have a D/E ratio of 1.00. The risk of both organisations may seem identical, but in reality, the second organisation bears a bigger risk. This is because borrowing in a short term is less expensive than in a long term. Long term debt is more vulnerable to changes in interest rates – if the interest rates go up, operations will be more expensive. If the interest rates go down, refinancing costs come into the picture. This also drives up expenses.

This can be seen in an example in eToro. Navigate to a stock of your choice, in this case, Apple (AAPL), and go to the Stats tab. Once there, scroll down to the Financial Summary section. Once there, you can navigate to the Balance Sheet view.

de_ratio_etoro

In this view, you can see both, the long term debt to equity and total debt to equity. Here it is expressed as a percentage.

DE_ratio_eToro

Limitations of D/E Ratio

It is extremely important to take into account the industry in which the organisation exists as different industries have different financial requirements and growth. A high D/E ratio may be the norm in one industry, whereas, a comparatively low ratio in another. An example, capital-intensive industries tend to have a higher D/E ratio, often over 1. Whereas technology companies could have lower ratios, often around 0.5. Utility stocks are a good example of this situation as they have high capital expenditure (which incurs a debt, which is cheap), slow growth but are able to maintain a steady income stream.

What D/E Ratio should you look for?

The answer, as always, it depends. On the nature of the industry. A ratio below 1 is considered comparatively safe and ratios higher than 2 could be risky.

I see a negative D/E Ratio, what does that mean?

This shows that an organisation has more liabilities than assets and is a very risky sign. Often, this could be a sign of upcoming bankruptcy.

If you have not already, do read about other important metrics of stock picking in our series. For the rest, feel free to practice using the eToro Demo Practice Account.


This Article is Part of A Total guidance list on How to pick individual stocks, make sure you go by the article one by one to get a bigger understanding of the total picture. 😉
  • How to Pick an individual stock Part 1 - The Strategy
  • How to Pick an individual stock Part 2 - 5 metrics to look at when stock picking
  • How to Pick an individual stock Part 3 - P/E Ratio (Price-Earnings ratio)
  • How to Pick an individual stock Part 4 - Earnings Per Share‎
  • How to Pick an individual stock Part 5 - Dividend Yield
  • How to Pick an individual stock Part 6- Company History And Strength
  • How to Pick an individual stock Part 7- Debt-Equity Ratio

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A Deep Dive Into Debt-Equity Ratio 1

GENERAL RISK WARNING

  • eToro is a multi-asset platform that offers: Stocks, Crypto assets, and CFDs.
  • CFDs are complicated and can make you lose money quickly because of leverage. 81% of retail investor accounts lose money when trading CFDs with this provider. Think about if you understand how CFDs work and if you can afford to take the risk of losing your money.
  • Past performance is not an indication of future results. Trading history presented is less than 5 complete years and may not suffice as basis for investment decision.
  • Copy Trading does not amount to investment advice. The value of your investments may go up or down. Your capital is at risk.
  • Cryptoasset investing is highly volatile and unregulated in some EU countries. No consumer protection. Tax on profits may apply.
  • eToro USA LLC does not offer CFDs and makes no representation and assumes no liability as to the accuracy or completeness of the content of this publication, which has been prepared by our partner utilizing publicly available non-entity-specific information about eToro.
  • Be warned!


Author & Expert Trader:

Bart Bregman
My name is Bart Bregman and I am a full-time professional trader with nine years of experience. I specialize in shorter-term trading using technical analysis, and I have extensive experience with Stocks, CFDs, Options, and Crypto trading. I believe that there is no such thing as a bad trade. I'm currently traveling the world as a digital nomad trader. You can follow my journey on Instagram at https://www.instagram.com/bart_bregman/

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GENERAL RISK WARNING

  • eToro is a multi-asset platform that offers: Stocks, Crypto assets, and CFDs.
  • CFDs are complicated and can make you lose money quickly because of leverage. 81% of retail investor accounts lose money when trading CFDs with this provider. Think about if you understand how CFDs work and if you can afford to take the risk of losing your money.
  • Past performance is not an indication of future results. Trading history presented is less than 5 complete years and may not suffice as basis for investment decision.
  • Copy Trading does not amount to investment advice. The value of your investments may go up or down. Your capital is at risk.
  • Cryptoasset investing is highly volatile and unregulated in some EU countries. No consumer protection. Tax on profits may apply.
  • eToro USA LLC does not offer CFDs and makes no representation and assumes no liability as to the accuracy or completeness of the content of this publication, which has been prepared by our partner utilizing publicly available non-entity-specific information about eToro.
  • Be warned!

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