Enterprise Value (EV)

Overview

Enterprise Value (EV) is basically a modification of market capitalization value adjusted for the company's debts and cash. It is a more thorough way of assigning valuation as it looks at the entire market value rather than just the equity value of a company.

Enterprise value is one of the fundamental metrics used when estimating value when acquiring a business. The calculation is not solely based on the equity value, but it adjusts for any short-term and long-term debts that the company has, as well as cash on the balance sheet.

Formula

Calculation: You can calculate the enterprise value of a company from the balance sheet. To calculate the market capitalisation, you would have to multiply the number of outstanding shares by the current stock price. The cash and the total debt number can be found on the company's balance sheet (including both short-term and long-term debt).

Components: Market Capitalisation = Outstanding Shares × Current Stock Price. Total Debt includes both short-term and long-term debt from the balance sheet. Cash and Equivalents includes cash and highly liquid short-term investments from the balance sheet.

Calculation Example

Let's calculate the enterprise value for a hypothetical company to demonstrate the process:

How to Interpret

One way to think about Enterprise Value is to think of the enterprise value as being the theoretical takeover price for the company. If someone is about to acquire the whole company, this will be the theoretical price paid.

Enterprise Value vs Market Cap:

Why It Matters

Enterprise value is a fundamental metric for acquisition analysis and company valuation, providing a more complete picture of a company's true value than market capitalization alone.

Key Insights:

• Theoretical Takeover Price: Enterprise value represents the theoretical takeover price for the company. If someone is about to acquire the whole company, this will be the theoretical price paid. It provides the true cost of acquiring a business, not just the cost of buying the equity. When an acquirer buys a company, they assume the debt (which must be repaid) and receive the cash (which reduces the effective cost), making EV the complete acquisition cost rather than just market cap.
• More Accurate Than Market Cap: Enterprise value is a more thorough way of assigning valuation as it looks at the entire market value rather than just the equity value of a company. It is more "accurate" than pure market capitalisation because it penalizes companies that have a lot of debt on their balance sheet (as the debt will eventually need to be repaid by the acquirer) and it awards companies that have cash on their balance sheet (as the acquirer receives this cash). This adjustment provides a realistic view of what it would actually cost to acquire and own the business.
• Capital Structure Neutrality: Enterprise value is useful for comparing companies with different capital structures because a change in capital structure will not affect the amount of enterprise value. Two companies with identical market caps may have completely different enterprise values based on how their balance sheet looks. A company with $5B market cap, $2B debt, and $0.5B cash has EV of $6.5B, while a company with $5B market cap, $0 debt, and $1B cash has EV of $4B. EV allows apples-to-apples comparison regardless of financing choices.
• Better Valuation Multiples: Enterprise Value is often used in multiples such as EV/EBITDA, EV/EBIT, or EV/Sales for comparing valuation of different companies. Using EV multiples instead of commonly used price multiples like PE, PB, PS has advantages as regular price-based multiples do not take into account cash and debt. EV multiples normalize for capital structure differences, making them more comparable across companies. For example, EV/EBITDA is preferred over P/E because EBITDA represents cash flow available to all capital providers (debt and equity), matching the EV numerator which represents the value to all capital providers.

Key Takeaways

• Enterprise Value (EV) is modification of market capitalization value adjusted for company debts and cash
• More thorough way of assigning valuation - looks at entire market value not just equity value of company
• Fundamental metric used when estimating value when acquiring a business
• Calculation not solely based on equity value but adjusts for short-term and long-term debts and cash on balance sheet
• Formula: EV = Market Capitalisation + Total Debt − Cash and Equivalents
• Can calculate from balance sheet: Market Cap = Outstanding Shares × Current Stock Price
• Total Debt includes both short-term and long-term debt from balance sheet
• Cash and Equivalents includes cash and highly liquid short-term investments from balance sheet
• Think of EV as theoretical takeover price for company - price paid if acquiring whole company
• More "accurate" than pure market cap - penalizes companies with lot of debt (debt needs repayment by acquirer)
• Awards companies with cash on balance sheet (acquirer receives this cash reducing effective cost)
• Useful for comparing companies with different capital structures - change in capital structure won't affect EV amount
• EV vs Market Cap: both measurements of company value but not identical or interchangeable
• Market cap is total value of outstanding shares based on current market pricing (equity value only)
• EV is theoretical takeover valuation - looks at entire market value including debt and cash not just equity value
• Two companies with identical market caps may have completely different enterprise values based on balance sheet
• EV often used in multiples: EV/EBITDA, EV/EBIT, EV/Sales for comparing valuation of different companies
• Using EV multiples instead of price multiples (PE, PB, PS) has advantages - price-based multiples don't account for cash and debt
• EV multiples more comparable across companies with different capital structures