What Is the Equity Multiplier? Definition, Formula, and Examples

What Is the Equity Multiplier?

The term equity multiplier refers to a risk indicator that measures the portion of a company’s assets that is financed by shareholders' equity rather than by debt. The equity multiplier is calculated by dividing a company's total asset value by the total equity held in the company's stock. A high equity multiplier indicates that a company is using a high amount of debt to finance its assets. A low equity multiplier means that the company has less reliance on debt. 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.

Understanding the Equity Multiplier

Investing in new and existing assets is key to running a successful business. Companies finance the acquisition of assets by issuing equity or debt. In some cases, they resort to issuing a combination of both. As an investor, you may want to determine how much shareholders' equity is being used to pay for and finance a company's assets. This is where the equity multiplier comes into play.

As noted above, the equity multiplier is a metric that reveals how much of a company's total assets are financed by shareholders' equity. Essentially, this ratio is a risk indicator used by investors to determine a company's position when it comes to 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 that a company is using a large amount of debt to finance its assets. Companies with a higher debt burden will have higher debt servicing costs, which means that they 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 a positive because its debt servicing costs are lower. But it may also send a signal that the company can't entice lenders to loan it money on favorable terms, which is a problem.

Formula for the Equity Multiplier

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

Interpreting the Equity Multiplier

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.

The equity multiplier is an important factor in DuPont analysis, which is 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 for the peer group, the DuPont analysis can indicate how much of this is attributable to the use of financial leverage. If the equity multiplier fluctuates, it can significantly affect ROE.

Examples of Equity Multiplier Analysis

The equity multiplier calculation is straightforward. 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).

Now let's compare Apple to Verizon Communications (VZ). The company has a very different business model than Apple. The company's total assets were $366.6 billion for the fiscal year 2021, with $83.2 billion of shareholders' equity. The equity multiplier was thus 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 thus 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 and is calculated by dividing total assets by shareholders' equity.

In general, lower equity multipliers are better for investors, but this can vary between industries and companies with particular industries. In some cases, a low equity multiplier could actually indicate that the company cannot find willing lenders; or it could also signal that a company's growth prospects are low.

On the other hand, a high equity multiplier is not always a sure sign of risk. High leverage can be part of an effective growth strategy, especially if the company is able to 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.