What does a higher debt/equity ratio indicate regarding a company's risk?

A higher debt/equity ratio indicates increased risk due to higher leverage because it reflects a greater proportion of debt financing relative to equity financing in a company's capital structure. When a company relies more on debt, it must generate sufficient cash flows to meet interest obligations and principal repayments. This dependency on debt can heighten the company's financial risk, especially in volatile market conditions or if the company experiences a downturn in operations.

Investors and creditors often perceive companies with high leverage as riskier because they may face difficulties in servicing their debt during periods of economic stress. This heightened level of financial obligation can lead to greater volatility in earnings and increase the likelihood of financial distress or bankruptcy if the company cannot meet its debt commitments. Essentially, while leveraging can magnify returns during periods of growth, it also increases overall risk, making it a critical factor for assessing a company's financial stability and investment appeal.