An equity multiplier shows how much leverage a company is using to fund its assets and shows the relationship between the value of a company’s assets and the value of its shareholders’ equity. Leverage is the use of debt to acquire assets. For example, an equity multiplier of 2 means a company’s assets are worth two times its shareholders’ equity. An equity multiplier of 1 means a company has no debt. Too much leverage can lead to financial trouble, which can reduce a company’s stock price. You can calculate a company’s equity multiplier to measure its leverage and compare its risk to other companies.
Find a company’s total assets and total stockholders’ equity on its balance sheet. For our example, we'll say that a company has $10 million in total assets and $4 million in total stockholders’ equity.
Divide total assets by total stockholders’ equity to calculate the equity multiplier. Divide $10 million by $4 million, which equals an equity multiplier of 2.5. This means the company’s assets are worth 2.5 times its stockholders’ equity, which suggests the company may be using too much leverage, depending on its industry.
Find the equity multipliers of the company’s direct competitors and the average equity multiplier for the industry in which the company operates on a financial website that provides stock quote information. For example, determine that two of the company’s competitors have equity multipliers of 1.2 and 1.4 and the industry average is 1.3.
Compare the company’s equity multiplier with the industry average equity multiplier. If the company’s equity multiplier is greater than the industry average, it may be taking on too much risk. If it is less than the industry average, the company is likely using a conservative amount of debt. For example, compare the company’s equity multiplier of 2.5 with an industry average of 1.3. The company’s equity multiplier is higher, which suggests the company is using risky debt levels.
Compare the company’s equity multiplier with those of its competitors. For example, compare the company’s equity multiplier of 2.5 with competitors’ equity multipliers of 1.2 and 1.4. The company’s equity multiplier is higher, which means its competitors are operating with lower risk than the company.
Calculate the company’s equity multipliers in previous years and compare them with the company’s current equity multiplier to identify any changes. For example, if the company’s equity multiplier has increased from 1.3 five years ago to 2.5 today, the company is relying on more debt to fund its assets than it has in the past, which could signal problems with the company’s operations.
