What is the Equity Multiplier (EM)?
By definition: The Equity Multiplier is the financial leverage ratio that measures the portion of a company’s assets that are financed by its shareholder’s equity. Therefore, Equity Multiplier can be calculated by dividing the company’s total assets by total shareholder’s equity.
This data are available in the company’s balance sheet and anyone can obtain it from there. The EM ratio tells about a company’s extent to which the company is financed by shareholder’s equity instead of debt. Hence, the higher the EM, the more the company is financed by debt rather than equity.
Equity Multiplier = Total Assets ÷ Total Shareholder’s Equity
Total Assets means the sum of the book values of all assets owned by the company. It is a parameter that is frequently used in total assets debt covenants. The worth of a company’s total assets is acquired in the accounting for depreciation associated with the assets.
Total Asset = Equity + Liability
Shareholder’s Equity is the amount that would be returned to the shareholder when all the assets are liquidated and the company’s debts are paid off.
Shareholder’s equity = Total Asset – Liabilities
How to calculate Equity Multiplier
Let us understand by an example, how to calculate EM.
Let the total asset of the company = $100 Million
And Shareholder’s equity = $20 Million
From the equation,
Equity Multiplier = Total Assets ÷ Total Shareholder’s Equity
If we put values in the equation,
EM = 100 ÷ 20
Therefore, EM = 5
This means most of the company’s assets are financed by debt.
It also means that the total assets financed by shareholder’s equity are 20 per cent. Whereas the balance of 80 per cent is financed through debt.
Here, the Equity Multiplier Ratio comes out to be 5, it means that the investment in total assets is 5 times the investment by equity shareholders. With this statement, we can also conclude that in the overall asset financing of a company, 1 part is equity and 4 parts are debt.
Understanding the EM
Investment in assets is important aspect in maintaining a profitable business. Companies finance their acquisition of assets by issuing equity or debt, or a combination of both.
The EM shows how much assets of a company are financed by shareholder’s equity. So we can find how much of the assets are financed by the external source (especially debt).
The finance leverage depends upon the equity multiplier. The higher the ratio lower the financial leverage, and the lower the ratio higher the financial leverage.
As an investor, you should look at the company’s multiplier to determine its financial leverage. It helps to know if the company is risky or not.
The EM helps you to pull out comparable companies in the same industry to calculate the equity multiplier. It will help you understand high and low financial ratios of the companies so you may select the company in which you want to invest. Therefore, if a company is financing its assets by debt is risky as compared to a company financing its assets with equity.
Therefore, it is important to look at the financial multiplier ratio.
How to calculate the Debt Ratio Using the Equity Multiplier
A company’s level of debt can be easily calculated by using debt ratio and equity multiplier. As most of the companies finance their assets through debt and equity, we can conclude that;
Total Capital = Total Debt + Total Equity
Also, we know that the debt ratio is directly proportional to Total Debt that is financed through the company’s Total Assets.
Therefore, Debt Ratio = Total Debt / Total Assets
For example, Let’s say a company XYZ has total debt of $200000 and total assets of $1000000.
From the Debt Ratio formula we can conclude that;
Debt Ratio = 200000/1000000
=0.2 or 20%
We can also determine the Debt ratio using the Equity Multiplier;
Debt Ratio = 1 – (1/Equity Multiplier)
Debt Ratio = 1 – (1/1.25) = 1 – (0.8) = 0.2 or 20%
DuPont Analysis
The DuPont Model was introduced by DuPont Corporation. It helps to breaks down the return on equity formula into the multiples of net profit margin, the asset turnover and the equity multiplier. When the Return On Equity (ROE) of a company changes, by DuPont analysis, we can determine the how much of this change is attributable to financial leverage. Therefore, when the value of Equity Multiplier changes, there is a change in the value of ROE.
Hence, the ROE formula:
ROE = Net Profit/ Shareholder’s Equity
And we know that;
Net Profit Margin = Net Income / Sales
Asset turnover = Sales / Average Total Assets
Equity Multiplier = Average Total Assets / Average Shareholder’s Equity
ROE = [Net Income / Sales] x [Sales / Average Total Assets] x [Average Total Assets / Average Shareholder’s Equity]
Therefore,
ROE = Net Profit Margin × Asset turnover × Equity Multiplier
EM for Auto Manufacturer Example
EM for some Auto Manufacturer.
| Name | Assets To Shareholder Equity |
|---|---|
| Ford Motor | 8.16x |
| General Motors | 5.06x |
| Honda Motor Co | 2.60x |
| Ferrari | 11.85x |
| Toyota Motor | 2.78x |
| Tesla | 4.77x |
| Tata Motors | 4.99x |
- From this table we can clearly draw a conclusion that Ferrari has the highest EM of 11.85x whereas, Honda Motor Co has a multiplier of 2.60x.
- EM of Auto Manufacturer industry is relatively higher.
EM for Internet and Content Companies Example
Let us have an overview of Multipliers for Internet Companies.
| Internet Companies Name | Assets To Shareholder Equity |
|---|---|
| Baidu | 1.97x |
| 1.10x | |
| Phoenix New Media | 1.46x |
| GoDaddy | 6.73x |
| Alphabet | 1.20x |
| Groupon | 6.66x |
| GrubHub | 1.23x |
| Shutterstock | 1.75x |
| 1.49x | |
| Yelp | 1.10x |
- Here we can see that some of the big companies like Facebook, Alphabet, GrubHub and Twitter has a multiplier of 1.10x, 1.20x, 1.23x and 1.49x respectively.
- Godaddy has the highest EM ratio among all the other companies.
Yelp and Facebook has the lowest multiplier of 1.10x
Global Banks Multipliers Example
At last, let’s have a look at some of the Global Banks Multiplier.
| Name | Assets To Shareholder Equity |
|---|---|
| Bank of America | 8.20x |
| Barclays | 18.70x |
| Bank of Montreal | 16.00x |
| Bank of Nova Scotia | 15.25x |
| Citigroup | 7.96x |
| Canadian Imperial Bank | 18.21x |
| Credit Suisse Group | 19.57x |
| East-West Bancorp | 10.15x |
| HSBC Holdings | 13.54x |
| ING Group | 17.82x |
| JPMorgan Chase | 9.80x |
| Mitsubishi UFJ Financial | 21.25x |
| Bank of N.T Butterfield | 15.62x |
| Royal Bank of Scotland | 16.43x |
| Royal Bank of Canada | 16.43x |
| Sumitomo Mitsui Financial | 19.24x |
| The Toronto-Dominion Bank | 17.24x |
| UBS Group | 17.44x |
| Wells Fargo | 9.67x |
- From this table we can conclude that Global Banks are amongst the Assets To Shareholder Equity.
- Mitsubishi UFJ Financial and Sumitomo Mitsui Financial has the EM of 21.25x and 19.24x respectively. Whereas Citigroup and Bank of America are among the lowest multiplier in Banking sector with 7.96x and 8.20x respectively.
Hence, from the above three tables, we can conclude that the EM depends on industry to industry. Therefore, before investment, you must check for the equity multiplier of different companies in the same industry.
Key Features
- 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.
- Equity Multiplier Formula
EM = Total Assets ÷ Total Shareholder’s Equity - Higher the equity multiplier means higher the company is financed through debt, whereas the lower Equity Multiplier means the more the comapny is financed through shareholder’s equity.
FAQ
What is a good equity multiplier?
Different industries have different equity multiplier ranges. Like, the Banking industry has a higher Equity Multiplier ratio as compared to the Auto Manufacturer industry. So we conclude that it depends from industry to industry. Therefore, you have to check for the equity multiplier of companies in your industry before investing in a company.
What is the equity multiplier definition?
The equity multiplier is a risk indicator that helps us determine how much of the company’s assets are financed by the shareholders’ equity and is a simple ratio of total assets to total equity.
Also Check:
Debt to Equity Ratio- How to calculate ROE
GROWTH STOCK MUTUAL FUNDS- It’s Easy If You Do It Smart