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 instead of by debt. It is calculated by separating a company's total asset value by its total shareholders' equity.

Generally, a high equity multiplier demonstrates that a company is utilizing a high amount of debt to finance assets. A low equity multiplier means that the company has less dependence on debt.

Notwithstanding, a company's equity multiplier should be visible as high or low just in comparison to historical standards, the midpoints for the industry, or the company's peers.

The equity multiplier is otherwise called the leverage ratio or financial leverage ratio and is one of three ratios utilized in the DuPont analysis.

Formula and Calculation of the Equity Multiplier

Grasping the Equity Multiplier

Interest in assets is key to running an effective business. Companies finance their acquisition of assets by giving equity or debt, or a mix of both.

The equity multiplier uncovers the amount of the total assets are financed by shareholders' equity. Basically, this ratio is a risk indicator utilized by investors to decide how leveraged the company is.

A high equity multiplier (relative to historical standards, industry midpoints, or a company's peers) shows that a company is utilizing a large amount of debt to finance assets. Companies with a higher debt burden will have higher debt servicing costs, and that means that they should produce more cash flow to support a sound business.

A low equity multiplier infers that the company has less debt-financed assets. That is typically viewed as a positive as its debt servicing costs are lower. Yet, it could likewise signal that the company can't tempt lenders to loan it money based on good conditions, which is a problem.

How Investors Interpret the Equity Multiplier

There is no optimal equity multiplier. It will shift by the sector or industry a company works inside.

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 contrived by the substance company for its internal financial survey. 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.

Assuming ROE changes over the long haul or separates from normal levels for the peer group, the DuPont analysis can demonstrate the amount of this is owing to utilization of financial leverage. On the off chance that the equity multiplier changes, it can altogether influence ROE.

Higher financial leverage (for example a higher equity different) drives ROE vertical, any remaining factors staying equivalent.

Instances of Equity Multiplier Analysis

The equity multiplier calculation is direct. Think about Apple's (AAPL) balance sheet toward the finish of the fiscal year 2019. The company's total assets were $338.5 billion, and the book value of shareholder equity was $90.5 billion. The company's equity multiplier was in this way 3.74 ($338.5 billion/$90.5 billion), a bit higher than its equity multiplier for 2018, which was 3.41.

Presently compare Apple to Verizon Communications (VZ). The company has a totally different business model than Apple. The company's total assets were $291.7 billion for the fiscal year 2019, with $62.8 billion of shareholder equity. The equity multiplier was 4.64 ($291.7 billion/$62.8 billion), in view of these values.

Verizon's higher equity multiplier shows that the business depends all the more intensely on financing from debt and other interest-bearing liabilities. The company's telecommunications business model is like utility companies, which have stable, unsurprising cash flows and commonly carry high debt levels.

Then again, Apple is more helpless to changing economic conditions or developing industry standards than a utility or a traditional telecommunications firm. Accordingly, Apple conveys less financial leverage. It has a relatively low equity multiplier.

Highlights

• The equity multiplier is a measure of the portion of the company's assets that is financed by stock as opposed to debt.
• Investors judge a company's equity multiplier with regards to its industry and its peers.
• Generally, a high equity multiplier shows that a company has a higher level of debt.