Equity Multiplier

What Is the Equity Multiplier?

The equity multiplier is a risk indicator that measures the portion of a company’s assets that is financed by stockholder's equity rather than by debt. It is calculated by dividing a company's total asset value by its total shareholders' equity.

Generally, a high equity multiplier indicates that a company is using a high amount of debt to finance assets. A low equity multiplier means that the company has less reliance on debt.

However, a company's equity multiplier can be seen as high or low only in comparison to historical standards, the averages for the industry, or the company's peers.

The equity multiplier is also known as the leverage ratio or financial leverage ratio and is one of three ratios used in the DuPont analysis.

Key Takeaways

  • The equity multiplier is a measure of the portion of the company’s assets that is financed by stock rather than debt.
  • Generally, a high equity multiplier indicates that a company has a higher level of debt.
  • Investors judge a company's equity multiplier in the context of its industry and its peers.
  • The equity multiplier is also known as the financial leverage ratio.

Equity Multiplier

Understanding the Equity Multiplier

Investment in assets is key to running a successful business. Companies finance their acquisition of assets by issuing equity or debt, or some combination of both.

The equity multiplier reveals how much of the total assets are financed by shareholders' equity. Essentially, this ratio is a risk indicator used by investors to determine how leveraged the company is.

A high equity multiplier (relative to historical standards, industry averages, or a company's peers) indicates that a company is using a large amount of debt to finance assets. Companies with a higher debt burden will have higher debt servicing costs, which means that they will have to generate more cash flow to sustain a healthy business.

A low equity multiplier implies that the company has fewer debt-financed assets. That is usually seen as a positive as its debt servicing costs are lower. But it could also signal that the company is unable to entice lenders to loan it money on favorable terms, which is a problem.

Formula for the Equity Multiplier

Equity Multiplier = Total Assets Total Shareholders’ Equity where: Total Assets = Both current and long-term assets Total Shareholders’ Equity = Total assets total liabilities \begin{aligned}&\text{Equity Multiplier} = \frac{ \text{Total Assets} }{ \text{Total Shareholders' Equity} } \\&\textbf{where:} \\&\text{Total Assets} = \text{Both current and long-term assets} \\&\text{Total Shareholders' Equity} = \text{Total assets} - \\&\text{total liabilities} \\\end{aligned} Equity Multiplier=Total Shareholders’ EquityTotal Assetswhere:Total Assets=Both current and long-term assetsTotal Shareholders’ Equity=Total assetstotal liabilities

How Investors Interpret the Equity Multiplier

An equity multiplier of 2 means that half the company's assets are financed with debt, while the other half is financed with equity.

The equity multiplier is an important factor in DuPont analysis, a method of financial assessment devised by the chemical company for its internal financial review. The DuPont model breaks the calculation of return on equity (ROE) into three ratios: net profit margin (NPM), asset turnover ratio, and the equity multiplier.

If ROE changes over time or diverges from normal levels for the peer group, the DuPont analysis can indicate how much of this is attributable to use of financial leverage. If the equity multiplier fluctuates, it can significantly affect ROE.

Higher financial leverage (i.e. a higher equity multiple) drives ROE upward, all other factors remaining equal.

Examples of Equity Multiplier Analysis

The equity multiplier calculation is straightforward. Consider Apple's (AAPL) balance sheet at the end of the fiscal year 2021. The company's total assets were $351 billion, and the book value of shareholder equity was $63 billion. The company's equity multiplier was therefore 351/63 = 5.57x.

Now compare Apple to Verizon Communications (VZ). The company has a very different business model than Apple. The company's total assets were $366.6 billion for the fiscal year 2021, with $83.2 billion of shareholder equity. The equity multiplier was thus 366.6/83.2 = 4.41x based on these values.

Apple's relatively high equity multiplier indicates that the business relies more heavily on financing from debt and other interest-bearing liabilities. Meanwhile, Verizon's telecommunications business model is similar to utility companies, which have stable, predictable cash flows and typically carry high debt levels. Apple is thus more susceptible to changing economic conditions or evolving industry standards than a utility or a traditional telecommunications firm. As a result, Apple carries more financial leverage.

Is a Higher Equity Multiplier Better?

Average equity multipliers will vary from industry to industry. In general, investors look for companies with a low equity multiplier because this indicates the company is using more equity and less debt to finance the purchase of assets. Companies that have higher debt burdens could be financially riskier.

What Is a Good Equity Multiplier?

There is no ideal equity multiplier. It will vary by the sector or industry a company operates within. In general, equity multipliers at or below the industry average are considered better.

What Does an Equity Multiplier of 5 Mean?

An equity multiplier of 5.0x would indicate that the value of its assets is five times larger than its equity. In other words, assets are funded 80% by debt and 20% by equity.

What Affects the Equity Multiplier?

A company's equity multiplier will vary if the value of its assets changes, and/or if the level of liabilities changes. If assets increase while liabilities decrease, the equity multiplier will grow bigger.

The Bottom Line

The equity multiplier is a financial ratio that measures how much of a company's assets are financed through stockholders' equity, and is calculated by dividing total assets by shareholders' equity. In general, lower equity multipliers are better for investors, but this can vary between industries and companies with particular industries. In some cases, a low equity multiplier could actually indicate that the company cannot find willing lenders; or it could also signal that a company's growth prospects are low. On the other hand, a high equity multiplier is not always a sure sign of risk. High leverage can be part of an effective growth strategy, especially if the company is able to borrow more cheaply than its cost of equity.

Article Sources
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  1. Apple. "Financial Statements."

  2. Verizon. "Annual Reports."