What Is the Equity Multiplier?

What Is the Equity Multiplier?

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

Debt and Financing

Companies finance the acquisition of assets by issuing equity or debt. In some cases, they use a combination of both. Investors monitor how much shareholders' equity is used to pay for and finance a company's assets. This ratio is a risk indicator to determine a company's leverage.

A company's equity multiplier is only high or low when compared to historical standards, the averages for the industry, or the company's peers:

• A high equity multiplier indicates a company uses a large amount of debt to finance its assets. Companies with a higher debt burden will have higher debt servicing costs and 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 positive because its debt servicing costs are lower. It may signal that the company can't entice lenders to loan it money on favorable terms.

Formula

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

Using the Equity Multiplier

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

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

Examples

Consider Apple's (AAPL) balance sheet at the end of the 2021 fiscal year. The company's total assets were $351 billion, and the book value of shareholders' equity was $63 billion. The company's equity multiplier was 5.57x (351 ÷ 63).

Let's compare Apple to Verizon Communications (VZ), which has a different business model. The company's total assets were $366.6 billion for the fiscal year 2021, with $83.2 billion of shareholders' equity. The equity multiplier for Verizon was 4.41x (366.6 ÷ 83.2) 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 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.

The Bottom Line

The equity multiplier is a financial ratio that measures how much of a company's assets are financed through stockholders' equity. Lower equity multipliers are generally better for investors, but this can vary between sectors. Conversely, high leverage can be part of an effective growth strategy, especially if the company can borrow more cheaply than its cost of equity.

Correction—Jan. 19, 2023: An earlier version of this article stated that a company's equity multiplier grows larger if its assets increase while its liabilities decrease. This was corrected to show that the reverse is true—that the equity multiplier becomes smaller because it uses less debt to finance its assets.