Debt to equity ratio

The debt to equity ratio of a company is simply its level of debt (any type of borrowed money – from bank loans to bonds issued by the company) divided by equity (the shareholders’ money in the business). Expressed as a percentage, this gives the companies ‘gearing’. A company with a high level of debt will have a high debt-to-equity ratio, and hence be ‘highly geared’.

A high level of gearing helps companies to produce better returns for shareholders when times are good, but in bad times, the highly geared are saddled with having to pay interest on their debt. Those which have chosen a high level of equity finance instead of debt, on the other hand, are not obliged to pay out – dividends are discretionary – and can often weather bad times better.

The appropriate mix of debt and equity depends on the type of business – those with stable long-term incomes (tobacco companies, for example) can better cope with being highly geared.

• See Tim Bennett’s video tutorial: Three ways leverage can boost your returns.

MoneyWeek magazine

Latest issue:

Magazine cover
Walking out on the banks

The UK's best-selling financial magazine. Take a FREE trial today.
Claim 3 FREE Issues
Shale gas 'fracking' promises to transform Britain's energy market. Find out what it is, what it means, and how to invest.

More from MoneyWeek

The problem with the Bank of England

Fracking: Nine reasons not to get carried away

Five small-cap stocks worth a flutter

This Dutch company could help us tame floods

ScreenHunter_01 Mar. 25 09.51

Get the latest tips and investment opportunities from MoneyWeek magazine: Claim 3 FREE issues HERE