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Along with D/E ratio, investors should also look for interest coverage ratio. Higher D/E ratio does not mean we should not invest in the stock. Rather, we should look for interest coverage ratio which tells us how company is placed to service its debt. If the interest coverage is more than 2, then it means the company can easily service its debt.

For example, the finance industry (banks, money lenders, etc.) typically has higher debt-to-equity ratios because these companies leverage a lot of debt (usually when granting loans) to make a profit.

On the other hand, the service industry has lower debt-to-equity ratios because they have fewer assets to leverage.

Many investors prefer to buy into companies that have a low debt-to-equity ratio. A company with fewer debts is less risky.

Let’s flip the tables and view the debt-to-equity ratio from a company’s perspective. If you’re a business owner, a high debt-to-equity ratio could impact your ability to get financing from creditors. For example, if you own a real estate company, a high debt-to-equity ratio could discourage lenders from giving you a mortgage loan. So the debt-to-equity ratio is an important number, whether you’re an investor or a business owner.

However, high debt is not necessarily an indicator that a company is struggling. Some investors prefer a higher debt-to-equity ratio. Some companies use debt to stimulate growth, in which case investors reap high returns if the growth plan is successful. We’ll discuss this in more detail.

When you’re doing stock research on a company, ask yourself the following questions:

What is the Average D/E Ratio for the Industry?
How is the Company’s Cash Flow?
How is the Company Using Its Debt?
Assume the Worst
What’s Your Risk Tolerance?