The debt-to-equity (D/E) ratio is a leverage ratio that shows how much a company's financing comes from debt or equity. A higher D/E ratio means that more of a company's financing is from debt versus issuing shares of equity. Banks tend to have higher D/E ratios because they borrow capital in order to lend to customers. They also have substantial fixed assets, i.e., local branches, for example.
Calculating the D/E Ratio
The D/E ratio is calculated as total liabilities divided by total shareholders' equity. For example, if, as per thebalance sheet, the total debt of a business is worth $60 million and the total equity is worth $130 million, then the debt-to-equity is 0.46. In other words, for every dollar in equity, the firm has 46 cents in leverage. A ratio of 1 indicates that creditors and investors are balanced with respect to the company’s assets. The D/Eratio is considered a key financial metric because it indicates potential financial risk.
The D/E Ratio and Risk
A relatively high D/E ratio commonly indicates an aggressive growth strategy by a company because it has taken on debt. For investors, this means potentially increased profits with a correspondingly increased risk of loss. If the extra debt that the company takes on enables it to increase net profits by an amount greater than the interest cost of the additional debt, then the company should deliver a higher return on equity (ROE) to investors.
However, if the interest cost of the extra debt does not lead to a significant increase in revenues, the additional debt burden would reduce the company's profitability. In a worst-case scenario, it could overwhelm the company financially and result in insolvency and eventual bankruptcy.
What Level of Debt-to-Equity Is Considered Desirable?
A high debt-to-equity ratio is not always detrimental to a company's profits. If the company can demonstrate that it has sufficient cash flow to service its debt obligations and the leverage is increasing equity returns, that can be a sign of financial strength. In this case, taking on more debt and increasing the D/E ratio boosts the company’s ROE.Using debt instead of equity means that the equity account is smaller and the return on equity is higher.
Bank of America's D/E ratio for the three months ending March 31, 2019, was0.96. In March 2009, during the financial crisis, the ratio reached 2.65, according to Macrotrends.
Typically, the cost of debt is lower than thecost of equity. Therefore, another advantage in increasing the D/E ratio is that a firm’s weighted average cost of capital (WACC), or the average rate that a company is expected to pay its security holders to finance its assets, goes down.
Overall, however, a D/E ratio of 1.5 or lower is considered desirable, and a ratio higher than 2 is considered less favorable. D/E ratios vary significantly between industries, so investors should compare the ratios of similar companies in the same industry.
In the banking and financial services sector, a relatively high D/E ratio is commonplace. Banks carry higher amounts of debt because they own substantial fixed assets in the form of branch networks.
FAQs
Although it varies from industry to industry, a debt-to-equity ratio of around 2 or 2.5 is generally considered good. This ratio tells us that for every dollar invested in the company, about 66 cents come from debt, while the other 33 cents come from the company's equity.
What is a good debt-equity ratio for banks? ›
Industry-wise Debt to Equity Ratio
| Industry | Typical Debt to Equity Ratio Range |
|---|
| Financial Services (Banks) | 4.0 – 8.0 |
| Telecommunications | 1.0 – 2.5 |
| Industrial Manufacturing | 0.4 – 1.0 |
| Consumer Discretionary (Retail) | 0.5 – 1.5 |
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The optimal debt-to-equity ratio will tend to vary widely by industry, but the general consensus is that it should not be above a level of 2.0.
What is the debt-to-equity ratio of US bank? ›
U.S. Bancorp Debt to Equity Ratio: 1.256 for March 31, 2024
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What is the most common debt-to-equity ratio? ›
Generally, a good debt ratio is around 1 to 1.5. However, the ideal debt ratio will vary depending on the industry, as some industries use more debt financing than others.
What is the debt-to-equity ratio of JP Morgan? ›
JPMorgan Chase Debt to Equity Ratio: 1.885 for March 31, 2024.
What is Goldman Sachs' debt-to-equity ratio? ›
The debt/equity ratio can be defined as a measure of a company's financial leverage calculated by dividing its long-term debt by stockholders' equity. Goldman Sachs BDC debt/equity for the three months ending December 31, 2023 was 1.14. Goldman Sachs BDC, Inc. is a specialty finance company.
What is the equity ratio in banking? ›
The equity ratio is a financial metric that measures the amount of leverage used by a company. It uses investments in assets and the amount of equity to determine how well a company manages its debts and funds its asset requirements.
Is 0.5 a good debt-to-equity ratio? ›
Generally, a lower ratio is better, as it implies that the company is in less debt and is less risky for lenders and investors. A debt-to-equity ratio of 0.5 or below is considered good.
What is the current US debt ratio? ›
The United States' debt-to-GDP ratio at the close of fiscal year 2023 was 97 percent. While this figure is down slightly from 100 percent in 2020, a 74-year high, the nation's fiscal outlook is still on an unsustainable path. Debt held by the public is on track to exceed GDP in 2025 and climb to 116 percent in 2034.
Average Debt to Equity Ratio by Industry
| Industry | Average debt to equity ratio | Number of companies |
|---|
| Household & Personal Products | 0.68 | 24 |
| Industrial Distribution | 0.65 | 17 |
| Information Technology Services | 0.6 | 53 |
| Insurance Brokers | 1.17 | 12 |
124 more rowsA debt ratio between 30% and 36% is also considered good. It's when you're approaching 40% that you have to be very, very vigilant. With a threshold like that, you're a greater risk to lenders. You may already be having trouble making your payments each month.
What is a really bad debt to equity ratio? ›
What is a bad debt-to-equity ratio? When the ratio is more around 5, 6 or 7, that's a much higher level of debt, and the bank will pay attention to that. “It doesn't mean the company has a problem, but you have to look at why their debt load is so high,” says Lemieux.
Is a debt ratio of 75% bad? ›
Interpreting the Debt Ratio
If the ratio is over 1, a company has more debt than assets. If the ratio is below 1, the company has more assets than debt. Broadly speaking, ratios of 60% (0.6) or more are considered high, while ratios of 40% (0.4) or less are considered low.
Is 3 a good debt to equity ratio? ›
A good debt to equity ratio is around 1 to 1.5. However, the ideal debt to equity ratio will vary depending on the industry because some industries use more debt financing than others. Capital-intensive industries like the financial and manufacturing industries often have higher ratios that can be greater than 2.
Is a 40% debt-to-equity ratio good? ›
Most lenders hesitate to lend to someone with a debt to equity/asset ratio over 40%. Over 40% is considered a bad debt equity ratio for banks. Similarly, a good debt to asset ratio typically falls below 0.4 or 40%. This means that your total debt is less than 40% of your total assets.
Is 50% debt-to-equity ratio good? ›
Yes, a D/E ratio of 50% or 0.5 is very good. This means it is a low-debt business and the company's equity is twice as high as its debts.
Is a debt-to-equity ratio of 0.75 good? ›
Good debt-to-equity ratio for businesses
Many investors prefer a company's debt-to-equity ratio to stay below 2—that is, they believe it is important for a company's debts to be only double their equity at most. Some investors are more comfortable investing when a company's debt-to-equity ratio doesn't exceed 1 to 1.5.
