Today is about equity multipliers.
Investors look for equity multipliers generally because this shows that the company uses less debt and more equity to buy assets. What is the reason why they want to confirm this fact? Companies with a massive debt burden are most likely financial risks. We can’t stress this more enough if the company is having problems making cash flow from operating activities needed to repay the debt and the related servicing costs like interest and fees. While we say this, it may not be true for all companies. Sometimes a high equity multiplier reflects the company’s strategy that can make it more profitable. It also allows the company to buy assets at a lower price.
How to calculate the equity multiplier
What is an equity multiplier? It is a ratio that can gauge a company’s financial leverage. And when we say leverage, we refer to the amount of money the company borrowed to buy assets. How do we calculate it? We take the company’s total assets and divide them by its total stockholder’s equity. For additional information, the stockholder’s equity is the same as shareholder’s equity. Below is a formula that we can use to calculate a company’s equity multiplier: Equity multiplier= Total assets/Total stockholder’s equity
Tell me more about multiplier equity.
If a company has a lower equity multiplier, it has lesser financial leverage. Many people might agree if we say that a low equity multiplier is better. It means that the company does not create any excessive debt to buy assets. The company buys assets it needs to operate its business through issuing stocks continuously. This is also how they improve their cash flow. An equity multiplier is something that investors can use to compare different companies from the same sector. We can also use this to compare specific companies versus the industry standard. There are many things that investors consider when they look for potential investments.
Things are not always as they seem.
A high equity multiplier does not always mean that there are more investment risks. Some companies believe that high debt is needed to buy assets at a lower price. This is true for companies that believe it is cheaper to incur debt as a financing method than issuing stocks. After all, not every company has the same strategy. If the company maximized the use of the assets and finally became profitable, it confirms that incurring debt is effective after all. On the other hand, this strategy also poses risks. If there is a sudden drop in profits, the company will struggle to pay its debts.
Inversely, a low equity multiplier does not always mean that it’s a good sign. It might mean that the company has a hard time finding entities willing to lend some money. A low equity multiplier can also signify that the company has minor growth prospects since its financial leverage is low.