We discovered that <i>Enterococcus faecium</i> (<i>E. faecium</i>), a ubiquitous commensal bacterium, and its secreted peptidoglycan hydrolase (SagA) were sufficient to enhance intestinal barrier function and pathogen tolerance, but the precise biochemical mechanism was unknown. Here we show <i>E. faecium</i> has unique peptidoglycan composition and remodeling activity through SagA, which generates smaller muropeptides that more effectively activates nucleotide-binding oligomerization domain-containing protein 2 (NOD2) in mammalian cells. Our structural and biochemical studies show that SagA is a NlpC/p60-endopeptidase that preferentially hydrolyzes crosslinked Lys-type peptidoglycan fragments. SagA secretion and NlpC/p60-endopeptidase activity was required for enhancing probiotic bacteria activity against <i>Clostridium difficile</i> pathogenesis <i>in vivo</i>. Our results demonstrate that the peptidoglycan composition and hydrolase activity of specific microbiota species can activate host immune pathways and enhance tolerance to pathogens.