What is the Equity Multiplier?
The equity multiplier helps us understand how much of the company’s assets are financed by the shareholders’ equity and is a simple ratio of total assets to total equity. If this ratio is higher, then it means financial leverage (total debt to equity) is higher. And if the ratio turns out to be lower, the financial leverage is lower. We note from the below graph that Go daddy has a higher multiplier at 6.73x, whereas Facebook’s Multiplier is lower at 1.09x.
Equity Multiplier Formula
Below is the formula –
Equity Multiplier = Total Assets / Total Equity
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For eg:
Source: Equity Multiplier (wallstreetmojo.com)
Along with finding out each unit of total assets for each unit of total equity, it also tells a lot about how much the company has financed its assets through external sources of finance, i.e., debt.
Let’s take an example to illustrate this.
Equity Multiplier Examples
Let’s say that Company Z has total assets of $100,000. Its total equity is $20,000. Calculate equity multiplier.
This is a simple example, but after calculating this ratio, we would be able to know how much assets are financed by equity and how much assets are financed by debt.
Or, Multiplier = $100,000 / $20,000 = 5.
The multiplier is 5 means that total assets are financed by 20% of equity ($20,000/$100,000 * 100 = 20%) and the rest (i.e. 80%) is financed through debt.
This is an important consideration since financial leverageFinancial LeverageFinancial Leverage Ratio measures the impact of debt on the Company’s overall profitability. Moreover, high & low ratio implies high & low fixed business investment cost, respectively. read more would be higher/ lower depending on the multiplier (whether the multiplier is higher or lower).
Interpretation
As an investor, if you look at a company and its multiplier, you would only be able to tell whether the company has been using high or low financial leverage ratios.
However, to know whether the company is at risk or not, you need to do something else as well.
You need to pull out other similar companies in the same industry and calculate equity multiplier.
If you see that the result is similar to the company you want to invest in, you would be able to understand that high or low financial leverage ratios are the norm of the industry.
That means if the company is financing its assets more by debt financing and the other companies in the industry have been doing the same, then this may be the norm.
But financing the assets through debt is still a very risky business. That’s why you need to go to the advanced calculation and look at the financial leverage ratiosLeverage RatiosDebt-to-equity, debt-to-capital, debt-to-assets, and debt-to-EBITDA are examples of leverage ratios that are used to determine how much debt a company has taken out against its assets or equity.read more in detail.
Let us now look at Multipliers of some sectors
Auto Manufacturer Example
Let us look at the multiplier of some of the prominent Auto Manufacturer
| Name | Assets To Shareholder Equity |
|---|---|
| Ford Motor | 8.16x |
| Fiat Chrysler Automobiles | 5.44x |
| General Motors | 5.06x |
| Honda Motor Co | 2.60x |
| Ferrari | 11.85x |
| Toyota Motor | 2.78x |
| Tesla | 4.77x |
| Tata Motors | 4.99x |
- We note that the equity multiplier of Ferrari is highest at 11.85x, whereas, the Multiplier of Honda Motor Co is lowest in the group at 2.60x
- Overall we note that Multiplier is relatively higher for this sector
Internet and Content Companies Example
Let us now look at the Multipliers for Internet Companies.
| Name | Assets To Shareholder Equity |
|---|---|
| Baidu | 1.97x |
| Care.com | 2.32x |
| 1.10x | |
| Phoenix New Media | 1.46x |
| GoDaddy | 6.73x |
| Alphabet | 1.20x |
| Groupon | 6.66x |
| GrubHub | 1.23x |
| JD.com | 4.73x |
| Snap | 1.30x |
| Shutterstock | 1.75x |
| 1.49x | |
| Yelp | 1.10x |
| Yandex | 1.48x |
We note that the biggies like Facebook (1.10x), Twitter (1.49x), and Alphabet (1.20x) have lower Equity Multipliers.
- GoDaddy has the highest Multiplier in this group at 6.73x.
- Yelp and Facebook have the lowest Multiplier in this group at 1.10x.
Global Banks Multipliers
Below is the list of Multipliers for Global Banks.
| 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 |
| Banco Santander | 14.73x |
| Sumitomo Mitsui Financial | 19.24x |
| The Toronto-Dominion Bank | 17.24x |
| UBS Group | 17.44x |
| Westpac Banking | 13.90x |
| Wells Fargo | 9.67x |
- Overall, we note that Global Banks have higher Assets To Shareholder Equity. In most cases, Multiplier is higher than 10x.
- JPMorgan has an equity multiplier of 9.80x, whereas, Citigroup has a multiplier of 7.96x (lowest in this group)
Discount Stores Multipliers
Below is the list of Multiplier for Discount Stores.
| Name | Assets To Shareholder Equity |
|---|---|
| Big Lots | 2.47x |
| Costco Wholesale | 3.37x |
| Dollar General | 2.16x |
| Dollar Tree Stores | 2.91x |
| Fred’s | 2.07x |
| Ollie’s Bargain Outlet | 1.60x |
| Pricesmart | 1.66x |
| Target | 3.42x |
| Tuesday Morning | 1.80x |
| Wal-Mart Stores | 2.56x |
- Overall, the Equity Multiplier in this group ranges from 1.5x -3.5x
- Target has the highest Multiplier at 3.42x, whereas Ollie’s Bargain Outlet has the lowest at 1.60x
Extension to Dupont Analysis
Equity Multiplier is very helpful in Dupont ROE Analysis. Under DuPont analysis, we need to use three ratios to find out the return on equity.
One of the ratios under DuPont analysis is the Assets To Shareholder Equity ratio.
ROE = (Profit/Sales) x (Sales/Assets) x (Assets/Equity)
You may ask why one should calculate ROE under DuPont analysis
It is simple. If the Assets To Shareholder Equity is higher, the ROE under DuPont analysis will also be higher.
And that’s how an investor will understand whether she will invest in the company or not, meaning she will get an advanced ratio to help her figure out whether she has come to the right conclusion by choosing / or not choosing to invest in the company.
Practical example
Company Usher has total assets of $400,000. The total equity of this company is $50,000. Ramesh, an investor, wants to know the equity multiplier as well as the ROE under DuPont analysis to see whether he should invest in the company or not. That’s why he looks into the annual report of the company and finds out the following details –
- Net income for the year – $40,000
- Sales – $200,000
Find out the multiplier and ROE under DuPont analysis for Ramesh.
We will follow the equity multiplier formula and will put the data we have into the formula to find out the ratios.
First, let’s Calculate the equity multiplier.
Or, Assets To Shareholder Equity = $400,000 / $50,000 = 8.
That means the 1/8th (i.e., 12.5%) of total assets are financed by equity, and 7/8th (i.e., 87.5%) are by debt.
Now, let’s calculate the ROE under DuPont FormulaDuPont FormulaDuPont formula determines the return on equity (ROE), depicting the efficient utilization of shareholders' capital into the business for generating revenue. The formula is "Return on Equity (ROE) = Profit Margin * Total Asset Turnover * Leverage Factor".read more analysis.
ROE under DuPont Analysis = Profit Margin * Assets Turnover Ratio * Equity Multiplier
Or, ROE under DuPont Analysis = Net Income / Sales * Sales / Total Assets * Total Assets / Total Equity
Or, ROE under DuPont Analysis = $40,000 / $200,000 * $200,000 / $400,000 * $400,000 / $50,000
Or, ROE under DuPont Analysis = 1/5 * ½ * 8 = 0.2 * 0.5 * 8 = 0.8.
Why should an investor depend on DuPont analysis after looking through multiplier?
This can be a big question in the investor’s mind.
The answer is threefold.
In Assets To Shareholder Equity, we get a sense of how much financially leveraged a company is.
If the equity multiplier is higher, financial leverage is higher and vice versa.
But what if the investor isn’t convinced only with the financial leverage?
Then, he needs to look at other aspects of the equation, i.e., the operational efficiency of the company and also the efficiency of the utilization of assets.
By calculating the ROE under DuPont analysis, the investor gets a clear idea of how much operational efficiency the company has plus how much efficiency of the assets the company has achieved.
In the example above, along with equity multiplier, we get an overview of operational efficiency (i.e., 20%) and efficiency of the utilization of the assets (i.e., 50%).
By looking at the whole picture, now an investor can decide whether to invest in the company or not.
Equity Multiplier Video
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This has been a guide to Equity Multiplier, its formula, examples, and sector ratios. You may have a look at the below readings to enhance your knowledge on Ratio Analysis –
