Equity Multiplier DefinedExamples, Formula, High and Low
What is the Equity Multiplier?
The equity multiplier is a financial leverage ratio that is used to measure what portion of a company’s assets are financed by equity instead of debt financing.
This is found by taking the value of a company’s total assets and dividing them by the total shareholder equity.
The equity multiplier is one out of the three ratios that make up the DuPont analysis.
Typically, the higher the equity multiplier, the more a company uses debt to finance its assets.
Whereas a lower equity multiplier means the company relies less upon debt.
When determining whether a company’s debt multiplier is high or low, it is important to consider factors such as the norm for the industry as well as its historical usage.
Equity Multiplier Formula
Equity Multiplier = Total Assets / Shareholder’s Equity
Understanding the Equity Multiplier
The equity multiplier can reveal a lot about a business and what level of risk it may pose to investors.
Investment in assets is a core component of business activities, and in order to do this, companies must finance this acquisition through either debt, equity, or some mixture of both.
The equity multiplier shows the degree to which a company’s assets are financed through the use of shareholder’s equity.
This ratio is often used by investors to find how leveraged a company is.
If a company’s equity multiplier is greater than the average for its industry and in relation to its peers, this indicates that the company is using more debt to finance its assets.
A greater debt burden often equates to higher debt servicing costs and the need for a higher cash flow to sustain business operations.
A lower equity multiplier generally indicates that a company utilizes less debt to finance its assets.
Investors often see this as a positive.
However, it may also indicate that a business is unable to acquire debt financing at reasonable terms, which is a serious issue.
How the Equity Multiplier is Interpreted by Investors
There is no specific equity multiplier that is best.
What is good in one industry or even a company may not necessarily be good in another.
If a business has a high equity multiplier with a considerable amount of debt yet has the revenue to cover the high debt servicing costs, then it may still be a healthy company.
However, it still remains a common useful guide for investors.
If a company has an equity multiplier of 2, this means that a company is equally financed by debt and stockholder equity.
A higher number means that the company is primarily debt-financed, and a lower number means that it is primarily equity financed.
As mentioned, the equity multiplier is frequently used as a component of the DuPont analysis which can provide a useful guide for investors.
The DuPont analysis, which is a financial assessment method, was conceived by the DuPont chemical company as a tool for internal review.
The DuPont model divides the calculation for return on equity (ROE) into three drivers.
These include the equity multiplier as well as asset turnover ratio, and net profit margin.
With the DuPont analysis, investors can compare a firm’s operational efficiency by determining how they are using their available assets to drive growth.
If a company’s ROE changes, the DuPont analysis can also show how much of this is due to the company’s use of financial leverage.
Assuming no other factors are changed, then higher financial leverage or, in other words, higher equity multiples will raise ROE.
Examples of the Equity Multiplier
Calculating the equity multiplier is not difficult.
The 2020 balance sheet for Kroger Co. shows the total assets for the company were $51,649 million, and the shareholder’s equity had a book value of $9,576 million.
This means the equity multiplier for Kroger Co. was 5.39, which was obtained by dividing the total assets of $51,649 million by the book value of the shareholder’s equity of $9,576 million to get an equity multiplier of 5.39 ($51,649/$9,576= 5.59). This is lower than the 2019 equity multiplier of 5.57.
Albertsons Cos, Inc. had total assets of $29,386 on their 2020 balance sheet, and the book value of their shareholder’s equity was $1,324.
This means their equity multiplier was 22.19, which is much higher than Kroger’s.
Both of these companies are grocery companies, with Kroger being the largest supermarket chain and Albertsons being the second-largest supermarket chain.
However, Albertsons is much more dependent on debt to finance its assets than Kroger is.
- The equity multiplier provides a measurement of how much a company’s assets are financed by equity instead of debt.
- A company’s equity multiplier must be judged in regards to its industry and competitors.
- Typically a higher equity number means that a company receives a higher ratio of its financing from debt instead of equity.
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Harvard Business School "Financial Performance Measures Managers Should Monitor" Page 1 . November 29, 2021
NYU Stern "Financial Ratios and Measures " Page 1 . November 29, 2021