Today’s online consumers have grown to love the “Compare Now” button that enables them to quickly compare products across some different categories. With the arrival of online investment portals, investors joined in and are constantly looking for metrics to compare the many available opportunities. Often these opportunities use different metrics such as IRR, Equity Multiple, Cash-on-Cash Return, Yield, etc. to describe their expected returns. In tandem, investors come across different metrics for different investments and are not sure how to compare them in an “apples-to-apples” lens.
Savvy investors are turning to a simple and powerful metric, the Equity Multiple, to compare the returns of different projects. An equity multiple is a simple equation—total dollars returned divided by total dollars invested.
Sometimes investors are looking for concrete concepts like the ‘rule of 72’. The rule of 72 is a quick way to calculate how long it takes to double your money. The equity multiple is similar in the sense that it tells you how much cash you are likely to get back over the course of the investment.
Total Dollars Invested
Time is not factored into the equation, so an investor should expect a higher equity multiple for a longer investment term. This provides a good balance to IRR which is very sensitive to the time duration of an investment. Let’s look at a few examples and interpret them.
A $300,000 investment in a residential rental property for three years. The property generates $24,000 net income per year (an 8% return) and it sold at the end of 3 years for $350,000 (about 5% annual appreciation). What is the equity multiple?
$300,000 Total Dollars Invested
Equity Multiple = 1.4x
A $300,000 investment was made into an S&P 500 index fund for 3 years starting in 2014 and achieving the following annual returns: 2014 – 13.69%, 2015 – 12.38%, 2016 – 11.96%. The $300,000 investment would be $387,132 at the end of three years. What is the equity multiple?
Equity Multipl = 1.3x
A $300,000 investment in a private debt fund, like Trueline Capital Fund II, that achieves the following annual returns paid out in current income: 2014 – 11.3%, 2015 – 10.8%, 2016 – 11.5%. The $300,000 investment would be $412,507 at the end of three years. What is the equity multiple?
Equity Multiple = 1.3x
Each of these investments generated a very similar equity multiple even though the timing of the cash flows was very different for each. Example one had current income with appreciation coming at the end. Example two was one investment and then all capital appreciation at the end of three years. Example three was all current income and then return of capital.
The equity multiple provides a balance to IRR because it equalizes investments that have different timing of cash flows and shows a “cash on cash” return. Also, long-term investments tend to have higher equity multiples while short-term projects have lower equity multiples because the returns accumulate over time – whereas IRR may become skewed on shorter-term investments.