Equity Multiplier Overview: Definition, Formula, Ratio, Analysis

Higher financial leverage drives ROE upward, all other factors remaining equal. This ratio is combined with other ratios, equations, and formulas, such as the DuPont Analysis. A high equity multiple indicates a company is using more debt to finance its assets.

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A ratio close to 2.5 is a typical EM value that will often gain approval from creditors and investors when looking for future loans. This value must only be compared to historical values, industry averages, and peer insight. Apple’s ratio of 2.346 indicates that the company incurs less debt servicing fees while enjoying less leverage. On the other hand, Verizon has a ratio of 12.895, showing the company is heavily reliant on debt financing and other liabilities. A low leverage value is deemed to indicate a healthy company due to decreased debt financing and service fees. As shown in the equation above, EM and ROE have a direct relationship.

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However, suppose the equity multiplier had risen while sales/assets and income/sales were static or declining. In that case, it’s possible ROE could have increased because the company was taking on debt. This means that a company’s assets are worth twice as much as the total shareholders’ equity. The higher this value, the more leveraged, or debt-heavy, the company is.

Relationship between debt ratio and equity multiplier

If ROE changes over time or diverges from normal levels for the peer group, the DuPont analysis can indicate how much of this is attributable to the use of financial leverage. An equity multiplier of two (2) means that half the company’s assets are financed with debt, while the other half is financed with equity. Investing in new and existing assets is key to running a successful business.

The equity multiplier is a useful tool for investors to monitor risk and understand how a company generates returns for investors. It’s helpful by itself and as part of a DuPont analysis, which is a financial tool that breaks out how a company generates a return on equity (ROE). 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. Because their assets are generally financed by debt, companies with high equity multipliers may be at risk of default. The Equity Multiplier ratio measures the proportion of a company’s assets funded by its equity shareholders as opposed to debt providers.

• Also known as stockholder’s equity, this term represents the net value that would belong to the shareholders if the company sold off all its assets and paid off all its liabilities.
• Consider the balance sheet of Apple Inc. (AAPL) as of the end of fiscal year 2017.
• A low equity multiplier implies a relatively small amount of debt (as the share of assets financed by shareholders’ equity is relatively high).
• Return on Equity (ROE) is another ratio that tells you how well a company is using its equity to generate profits.
• Total equity is on a company’s balance sheet or in its shareholder’s equity section.
• However, this also signals a higher level of financial risk, which might be a red flag for conservative investors.

This value must only be compared to historical standards, industry averages, or company peers. A lower ratio is more attractive but does not always signify a better option. An EM is only seen as high or low compared to averages in the industry, historical standards, or company peers. Consider enrolling in an online course that focuses on investment strategies or financial analysis.

A figure like 1.5 suggests moderate risk and leverage, often indicating a balanced approach to asset financing. Like other financial leverage ratios, the equity multiplier can show the amount of risk that a company poses to creditors. In fact, creditors and investors interested in investing in a company use this ratio to determine how leveraged a company is. The company may also be unable to obtain further financing to expand its market reach.

However, this also signals a higher level of financial risk, which might be a red flag for conservative investors. In general, investors look for companies with a low equity multiplier the equity multiplier is equal to because this indicates the company is using more equity and less debt to finance the purchase of assets. Companies that have higher debt burdens could be financially riskier.

This is because it is calculated by dividing total assets with total equity. Since both total assets and total equity are positive https://www.bookstime.com/ numbers, equity multiplier will always be a positive number. It’s calculated by dividing a firm’s total assets with total equity.

The equity multiplier was thus 4.41x (366.6 ÷ 83.2) based on these values. Total assets are on a company’s balance sheet, while total equity is on a company’s balance sheet or in its shareholder’s equity section. The interpretation of the equity multiplier levels should not be done separately from other figures that may help in understanding the financial position of a company.