Equity method investment
AccountingA stake carrying significant influence but not control, reported as one line below operating profit and subtracted in the bridge.
Also written: equity method investments, equity method, investment in associates
Where a holding brings significant influence without control, typically around twenty to fifty percent, the investee is not consolidated. The investor reports a single line, share of profit of associates, below operating profit, and carries the investment on its balance sheet at cost plus its accumulated share of profits less dividends received.
The consequence for valuation is precise. None of the associate's revenue or EBITDA reaches consolidated EBITDA, so an enterprise value built to sit above that EBITDA contains none of the associate's value either. Subtracting the investment from enterprise value is what keeps the numerator and the denominator describing the same set of operations.
This is the exact mirror of non controlling interests, and the direction is a reliable test of understanding. Consolidation brings in all of a subsidiary the parent does not fully own, so the outside claim is added. The equity method brings in none of an associate the parent partly owns, so the value of that stake is taken out.
The carrying value is a poor estimate of worth. It is an accounting accumulation rather than a market number, and a stake held for a decade in a business that has grown can sit far below its value. Use the associate's own market capitalisation multiplied by the stake if it is listed, and its own multiple if it is not.
Worked example
A group owns 30% of an associate that itself generates 100 of EBITDA. Consolidated EBITDA excludes all of it, and only the group's share of net income appears, below operating profit.
If that associate is worth 8.0 times EBITDA, the group's stake is worth 30% of 800, or 240, and that is what comes out of enterprise value.
The balance sheet might carry it at 110. Using 110 would leave 130 of value inside a multiple that has no corresponding earnings underneath it.