Debt Equity Ratio

Debt equity ratio measures the total liability (e.g. short + long term debt and associated interest) of a company relative to shareholder's equity. It is calculated through dividing total liability by shareholders' equity presented in consolidated balance sheet. A high ratio means the company is relying heavily on debt (i.e. borrow money) to make profit (if any), and a harder time to recover during economic downturn. While rarely seen, debt equity ratio can be negative when a company has negative equity (liability > assets), in which case the company will be hard to survive.

Similar to price earnings ratio, lower debt equity ratio is generally preferred when comparing two companies within the same industry, or sector^*. Thus the inverse value (i.e. 1/debt equity ratio) is used to generate quantile ranking score [0~1]. Higher score (i.e. closer to 1) represents relatively lower debt equity ratio and better performance. Lower score (i.e. closer to 0) represents relatively higher debt equity ratio and poorer performance. Companies with negative debt equity ratio (due to negative equity) always have very low score, and have performance monitor shown in pink color to indicate that it is a negative value. However, there is no specific interpretation for negative debt equity ratio.

^* large companies with good credit credential may have higher debt equity ratio than small companies. It should also be pointed out that an extemely low debt equity ratio may represent a company is not using leverage efficiently.

Debt equity ratio has industry and sector specific distribution (e.g. Utilities and financial companies generally have much higher debt equity ratio than industrial companies), so it only makes sense to compare debt equity ratio within the same industry, or sector. For comparing companies from different industries/sectors, it is more reasonable to compare their performances relative to corresponding industry/sector peers dictated by performance monitor.

Example 1: Approach Resources Inc. (NASDAQ:AREX), a Texas based small shell oil company, has debt equity ratio of 0.96 as of 2016-11-05. Denbury Resources Inc. (NYS:DNR), another Texas based shell oil company, has debt equity ratio of 4.69 at the same time

The debt equity ratio of AREX and DNR is better (lower) than 62% and 29% of industry peers, respectively. While at the whole market level, they are better than 63% and 26% of other companies

Historical Data

Analysis of historical data in the past 2 years indicates the debt equity ratio of DNR was constantly higher than AREX. The debt equity ratio of DNR was constantly higher than 1, and significant increased after Oct 2015. Note that debt equity ratio larger than 1 represents majority of assets are financed through debt. On the other hand, the performance of AREX relative to industry peers has no obvious change. The performance of DNR dropped significantly. Without considering other covariates, this single piece of information suggests AREX is a better choice than DNR at the time of writing.