This ratio indicates how much debt the company has got for every Rs 1 of shareholder’s equity.
Debt to Equity Ratio = Toral Borrowings / Shareholder’s Equity
If the company has a total borrowing (debt) of Rs 1000 Cr and the Shareholders’ equity is Rs 500 Cr. The D/E ratio is 2 (1000 / 500).
For every Rs 1 of shareholder’s equity, the company has a debt of Rs 2.
How to use it practically
The high Debt to Equity ratio tells that, the company has got high borrowing relative to shareholder equity. Generally, capital-intensive businesses like manufacturing may have a high D/E ratio because they need to invest a huge amount of money upfront to get profit in the future.
But as individual investors, we must prefer investing in a business that requires low or no debt from banks, because their business itself is so strong that, the business is generating a huge amount of profit.
The trend of the D/E ratio must be kept in check by the management so that, interest payment doesn’t become a burden for the company.
Normally debt to equity ratio of 1 or below is considered to be a prudent metric. In case, If you want to invest in high debt companies look for two things. First – check whether the company has got high OPM, Second check the interest coverage ratio of the company.