A high debt-to-equity ratio generally means that a company has aggressively financed its growth with debt. This could make earnings more volatile due to the additional interest expenses incurred. For capital intensive industries, a debt-to-equity ratio of 2 is considered normal.
The above chart shows that Penn National Gaming, Inc.’s (PENN) debt-to-equity ratio of 1.4 is well below 2. It’s also the lowest of its peers which include Pinnacle Entertainment, Inc (PNK), Boyd Gaming Corporation (BYD), and MGM Resorts International (MGM). Caesars Entertainment Corp’s (or CZR) debt-to-equity ratio isn’t meaningful because its equity value is negative.
ETFs such as the Consumer Discretionary Select Sector SPDR Fund (XLY) track the performance of these companies.
A company can generate more earnings if a lot of debt is used to finance additional operations, even if it results in high debt-to-equity. If earnings are that much greater than the interest cost of the debt, shareholders win. Meanwhile, sometimes the cost of financing debt outweighs the returns generated. This scenario could become difficult for a company to manage, lead to bankruptcy, and leave the shareholders with nothing.
A debt-to-equity ratio of 1 means that shareholders and debt holders have an equal stake in the business’ assets. Companies with a higher debt-to-equity ratio are considered riskier for stakeholders.
In the concluding part of this series, you’ll learn about Wall Street analysts’ outlook for PENN.