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What is the 'Equity Multiplier'

The equity multiplier is calculated by dividing a company's total asset value by total net equity, and it measures financial leverage. Companies finance their operations with equity or debt, so a high equity multiplier indicates that a larger portion of asset financing is attributed to debt. The equity multiplier is a variation of the debt ratio, and its definition of debt financing includes all liabilities.

!--break--Calculation of the equity multiplier is relatively simple and straightforward. Consider the balance sheet of Apple Inc. as of March 2016. The company's total assets were $305 billion, and the book value of shareholder equity was $130 billion. The company's equity multiplier was therefore 2.34. Verizon Communications Inc. operates a very different business model with more financial leverage. The company's total assets were $245 billion as of March 2016, with $19 billion of shareholder equity. The equity multiplier was 13.1, based on these values.

Leverage Analysis

Verizon's much lower proportionate shareholder equity value indicates that the business relies more heavily on financing from debt and other liabilities. The company's telecommunications business model is reminiscent of utilities firms, which have stable, predictable cash flows and typically carry high debt levels. Verizon's closest peer, AT&T Inc. also has one of the highest equity multipliers among the largest companies traded on U.S. exchanges, though it is much lower at 3.3 than Verizon's ratio of 13.1.

Apple is an established, mature business that can comfortably service debt, and it has issued notes to gain access to capital at relatively attractive costs. However, the company is more susceptible to changing economic conditions or evolving industry standards than utilities or large telecommunications firms. As a result, Apple has less financial leverage. These differences in business models mean that higher financial leverage does not necessarily indicate superior financial health.

DuPont Analysis

The equity multiplier is an important factor in DuPont analysis, which is a method of financial assessment devised by the DuPont Corporation for the purpose of internal review. The DuPont model breaks return on equity (ROE) into its constituent pieces, which are popular financial ratios and metrics. Net profit margin, asset turnover and the equity multiplier are combined to calculate ROE, which allows analysts to consider the relative of each impact separately. If ROE changes over time or diverges from normal levels for the peer group, DuPont analysis indicates how much of this is attributable to financial leverage. If the equity multiplier fluctuates, it can significantly impact ROE. Higher financial leverage drives ROE upward, all other factors remaining equal.

BREAKING DOWN 'Equity Multiplier'

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