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Equity Multiplier | Formula | Examples | How it Works?

Equity Multiplier – The purpose of Equity Multiplier is to see how much assets of a company are financed by the total shareholders’ equity, so that we can find out how much assets of the company are financed by the external sources of finance.

In this article, we will have a closer look at the this ratio and how it works.

Let’s have a look.

What is Equity Multiplier?

Equity Multiplier

This is one of the financial leverage ratios which help an investor find out how much assets are being financed by the shareholders’ equity.

Equity Multiplier is the ratio of total assets and total equity.

If the ratio is higher, the financial leverage is lower. And if the ratio turns out to be lower, the financial leverage is higher. We note from the above graph that Godaddy has a higher equity multiplier at 6.73x, whereas, Facebook’s Equity Multiplier is lower at 1.09x.

Equity Multiplier Formula

Equity Multiplier Formula = Total Assets / Total Equity

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 calcluating equity multiplier we would be able to know how much assets are financed by equity and how much assets are financed by debt.

We just need to put the figure into the equity multiplier formula.

Equity Multiplier = Total Assets / Total Equity

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 leverage would be higher/ lower depending on the multiplier (whether multiplier is higher or lower).

Equity Multiplier 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 calcluate 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 is 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 computation and look at the financial leverage ratios in detail.

Let us now look at Multipliers of some sectors

Equity Multiplier of Auto Manufacturer

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 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

Equity Multiplier for Internet and Content Companies

Let us now look at the Multipliers for Internet Companies.

Name Assets To Shareholder Equity
Baidu 1.97x
Care.com 2.32x
Facebook 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
Twitter 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 highest Multiplier in this group at 6.73x
  • Yelp and Facebook have lowest Multiplier in this group at 1.10x

Equity Turnover – Global Banks

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 Groep 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 a higher Assets To Shareholder Equity. In most cases, Multiplier is higher than 10x.
  • JPMorgan has an equity multiplier of 9.80x, whereas, Citigroup has an  multiplier of 7.96x (lowest in this group)

Equity Multiplier for Discount Stores

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 highest Multiplier at 3.42x, whereas Ollie’s Bargain Outlet has lowest at 1.60x

Extension of Equity Multiplier 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 Assets To Shareholder Equity ratio.

ROE = (Profit/Sales) x (Sales/Assets) x (Assets/Equity)
ROE = Net Profit Margin x Asset Turnover x Equity Multiplier

You may ask why one should compute 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 into 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 into 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 into 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 equity multiplier and ROE under DuPont analysis for Ramesh.

We will follow the equity multipler formula and will put the data we have into the formula to find out the ratios.

First, let’s Calculate equity multiplier.

Equity Multiplier formula = Total Assets / Total Equity

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 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 lower 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. operational efficiency of the company and also the efficiency of the utilization of assets.

By computing 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.

Suggested Readings

  • Current Ratio
  • Asset Turnover Ratio
  • Capitalization Ratio
  • DSCR Ratio
  • Ratio Analysis Guide

The post Equity Multiplier | Formula | Examples | How it Works? appeared first on Learn Investment Banking: Financial Modeling Training Online.



This post first appeared on Free Investment Banking Tutorials |WallStreetMojo, please read the originial post: here

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