I read from many websites that explain the criteria for selecting shariah compliant stocks that the maximum debt ratio a company can have is up to 1/3. I am wondering what the reason for this number is. Why is it limited only to that much and what shar’i evidence do they quote for basing that number off of?
Because debt is inherently risky, lenders and investors tend to favor businesses with lower D/E ratios. For lenders, a low ratio means a lower risk of loan default. For shareholders, it means a decreased probability of bankruptcy in the event of an economic downturn. A company with a higher ratio than its industry average, therefore, may have difficulty securing additional funding from either source.