Fundamental Analysis -Part 1

 Debt to equity ratio

Debt to equity ratio indicates the proportion of debt and equity in the financial structure of the company. Technically, it s used to measure the financial leverage of the company which is obtained by dividing companies total liabilities by the total equity of it. It gives clarity regarding the fund arranged by the company that weather it is by debt or by selling off share of its ownership.

          Having a debt is not a bad thing for any company but most important thing is that Weather Company is able to generate profit more than pay of interest. Lower debt-to-equity ratio are considered favorable because it indicates less risk in financial structure whereas high debt to equity ratio is unfavorable because it show risk. High debt to equity ratio is considered risky because it means that company relies more on external lenders for capital and at the same time it have to pay high interest rates for it which reduces the profit margin of the company.

          Debt-to-equity ratio of 1 means that half of the finance or asset of the company is by debt and half by equity shareholders. Debt to equity value higher than 1 means portion of debt in companies financial structure is more than  shareholder portion which is risky and when debt to equity ratio is less than 1, it means debt portion is less than that of shareholder portion.

          Before analyzing for any company and just considering it good or bad on the basis of the debt to equity ratio one should compare it with peer companies and should check for the industry type as I have said earlier that having debt is not a bad thing if company can earn more than that of interest which is to be paid. Ex construction, telecoms, power generation companies will always have debt in their balance sheet which can be 2 or even more. 

Formula

Debt-to-Equity Ratio = Total Liabilities/Shareholders' Equity

Ex- let total liability of company A be $4534000 and shareholder’s equity of $5493000. Then debt-to-equity ratio will be 4534000/5493000= 0.82 which is less than 1 which shows favorable condition for the company.

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