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What is Debt to Equity Ratio?
Despite how intimidating the term sounds, debt to equity ratio is a lot easier to understand than you might imagine. Sure, banks and investors toss the term around in a way that may have you sinking in your seat but it’s really not that complex, they just want you to think that it is!
There are quite a few elements that are used by investors who are trying to determine which stocks will offer them the greatest return on their investment. These are the stocks that they want to add to their personal portfolio. A company’s debt to equity ratio just happens to be one of these elements.
Debt to equity ratio basically measures the leverage that a company has. This is a good indication of their solvency, which is how much total liabilities are exceeded by total assets. If the number is negative, the company isn’t a good risk, if it’s positive, the company is very attractive (from the investment standpoint).
Financial institutions generally use the debt to equity ratio not only to determine if the company is a sound investment but also to decide an interest rate that should be offered. A company with a high ratio will traditionally be required significant repayment against the debt because of the risk the lender is taking.
On the other hand, companies who offer an attractive debt to equity ratio are eligible for foreign investment, lower rates and more opportunities that would otherwise not be available.
Calculations
Determining debt to equity ratio is relatively simply. You are trying to determine the ratio that remains after liability is divided by equity from all the shareholders. Simply put, this is the figure you get when you subtract liabilities from assets.
Mortgages, loans and accounts payable are all considered liabilities. An even easier way to understand debt to equity ratio is it’s the amount that is owed divided by what is owned. The lower the number, the more attractive the investment.
Using These Figures
If you are looking to invest in a company, debt to equity ratio must play a key role. A high ratio should raise a red flag that a company either needs to deal back is spending or it’s simply not profitable. On the other hand, a low ratio doesn’t always prove success, it could also be an indication of a stagnant company.
When using debt to equity ratio, you always want to compare these figures with the market and competition. A number that doesn’t seem attractive to you may fall right in line with the current market.
Conclusion
To cash in gains from stocks, you have to understand that even though there is no direct way to analyze any stock but you can use some fundamental metric measures to your advantage. Some metrics that are more important than the others and here’s five of them.
Are there any metrics that you love… but didn’t see on this list?
Or maybe you have a question.
Either way, let me know by leaving a comment below right now.