What does a higher debt-to-equity ratio indicate?

A higher debt-to-equity ratio indicates higher financial leverage because it reflects a greater proportion of debt in relation to equity. This means that a company is using borrowed funds to finance its operations and growth, which can amplify both potential returns and risks.

When a company utilizes more debt, it can achieve higher levels of investment and, subsequently, potentially higher profits. However, increased financial leverage also implies that the company has greater obligations to repay that debt, which can lead to financial strain, especially during downturns in the economy or declines in revenue.

Thus, a higher debt-to-equity ratio does not suggest lower financial risk or more stability in earnings; in fact, it points out the opposite—a reliance on debt financing that exposes the company to higher risks if unable to meet its financial commitments. Similarly, it does not indicate less reliance on external financing, as a higher ratio inherently signifies greater use of external debt compared to equity in the company’s capital structure.