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The debt to equity ratio measures the portion of the company's capital supplied by lenders ("debt") against that provided by owners ("equity"). There are various ways to compute the debt to equity ratio, because certain securities (like preferred stock) have characteristics of both debt and equity. But put simply, the debt to equity ratio is bonds divided by shareholder capital, which includes retained earnings. The debt to equity ratio indicates how much protection the company’s creditors have: the lower the company's debt to equity ratio, the bigger the financial cushion to pay bondholders. But a debt to equity ratio of zero may not be ideal. If the returns generated by new bonds outweigh the costs to service them, a company will often take on additional debt even though that will increase its debt to equity ratio. Thus a high debt to equity ratio can indicate a troubled business, but also an aggressive company eager for profits. |
