For anybody in the business or financial industries, knowing the actual value of a company is paramount in order to make sound business or investment determinations. This is not only for the investor to make better decisions but also to give a more accurate overall view of a company’s financial worth and health. Not only for today, but for the future, since having this information enables investors and analysts to forecast fiscal health and earnings of the company.
With that being the case, you can see how important it is to use the appropriate metrics to gauge the value of a company. Although many different types of measurements are available, two are standard in the industry: market cap and enterprise value.
What Is Market Cap?
Market cap, which is short for market capitalization, is the market value of a company’s stock. Therefore, in order to calculate the market cap, you need to know some vital information from the company regarding the number of shares it has issued and the current price of those shares.
The number of “shares outstanding” (which includes preferred stock as well as common stock) is what is required for this calculation. What it does not count are any shares that are considered “treasury stock,” which are the number of shares that are held in the company and not issued to investors. The simple formula for determining market cap is to multiply the number of shares outstanding by the current price per share.
MARKET CAP = SHARES OUTSTANDING x PRICE PER SHARE
Since you’re dealing with a public company, this information is readily available on its balance sheet or online at any financial website. Obviously, a company’s market cap can fluctuate wildly, if some factors cause the shares to rise or fall sharply. It’s also important to note that since market cap is based on such a simple formula, there are really no variations to this valuation, meaning “it is what it is.”
What Is Enterprise Value?
Similar to market capitalization, enterprise value is a way to measure a company’s value. Because it takes several more factors into account than a market cap valuation does, the formula for calculating the enterprise value of a company is more complex to work with. As a result of this, it is considered a deeper dive into the financials of a company.
Enterprise value brings some additional factors into the mix (besides the shares outstanding and price per share that are used in market cap), which are the following.
- Debt: This is the liability that a company incurs and that is on its books.
- Minority shares: These are the shares that “minority shareholders” own, which are less than 50% of the corporation’s shares.
- Preferred equity (or preferred stock): Preferred equity is a situation in which the shareholders have a higher claim to dividends or asset distribution over common shareholders.
- Cash (and cash equivalents): This is the cash on a company’s balance sheet, which also includes company assets that can be converted to cash. These cash equivalents must have a maturity date of three months or less.
So, the formula for enterprise value is the following.
ENTERPRISE VALUE = MARKET CAP + DEBT + MINORITY SHARES + PREFERRED EQUITY – CASH AND CASH EQUIVALENTS
As is the case for researching market cap, all of these figures are available from a company’s balance sheets, or on any major financial website.
Variations on the Enterprise Theme
Naturally, with so many moving parts, there are several different types of enterprise value (EV). In order to dig deeper into a company’s financials, one of these EV ratios may be employed. These include the following.
- EV/EBIT – Earnings before interest and taxes
- EV/EBITDA – Earnings before interest, taxes, depreciation and amortization
- EV/CFO – Cash flow from the operation
- EV/FCF – Free cash flow
- EV/Sales or Revenue
Except for EV/EBIT and EV/EBITDA, these formulas are self-explanatory. However, EV/EBIT and EV/EBITDA require some explanation. EV/EBIT is the ratio of the enterprise value to EBIT (earnings before interest and tax), which is a calculated number that represents recurring operating profit. Similarly, EV/EBITDA is the ratio of the enterprise value to EBITDA (earnings before interest, tax, depreciation and amortization). Again, this data is available in the company’s balance sheet or from any financial website.
Finally, there is a ratio of EV/market cap. Simply divide the enterprise value by the market cap, and there it is.
Market cap: $176m
Enterprise value: $250m
Using these figures, your company has an EV/market cap ratio of 1.4
Enterprise Value vs. Market Cap
Obviously, enterprise value versus market cap are two different ways of gauging the value of a company. Depending on exactly what you’re looking to accomplish, either the market cap alone or the market cap along with the enterprise value will be enough for you to glean what you want from the data available.
The takeaway: Market cap is more of a “quick and dirty” way to determine the value of a company, as its simple formula omits some important factors, namely cash on hand and the outstanding debt of the company. It is best suited for comparison to other companies operating within the same sector and/or industry. Enterprise value (and its variations) provide a much more holistic view of a company’s financial health (or lack thereof). The company’s enterprise value also factors in the market cap, so in theory, both figures are required for accurately valuing a company.
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Chris Capelle is a technology expert, writer and instructor. For over 25 years, he has worked in the publishing, advertising and consumer products industries.
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