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Enterprise value (EV) is a metric that captures a company’s total value by adding outstanding debt to its market capitalization, and then subtracting cash or cash equivalents from the balance sheet.
EV differs from a company’s market capitalization and its book value in that it accounts for these extra factors — the company’s debt and any cash or cash equivalents. As a metric, it can be used as part of fundamental analysis for stocks.
EV is one of many measures investors can use to compare businesses before they invest. Investors sometimes use EV as a more comprehensive metric than market capitalization when evaluating companies.
Key Points
• Enterprise Value (EV) is a comprehensive metric used to estimate a company’s total value by factoring in its market capitalization, cash, and debt.
• Unlike market capitalization, EV provides a more accurate representation of a firm’s value by including cash and debt obligations.
• The basic formula for calculating EV is: Market Capitalization + Market Value of Debt – Cash and Cash Equivalents.
• Investors can use EV to determine the effective cost of acquiring a company, making it a key metric for identifying potential takeover targets.
• EV is frequently used in conjunction with other metrics, such as the EV/sales ratio or the EV/EBITDA ratio.
• Because different industries use debt differently, EV is most effective when comparing companies within the same sector.
Defining Enterprise Value
Enterprise value, or EV, is one way of estimating a company’s total value, when factoring in its cash and its debts. It’s a relatively quick way to determine what a company is worth when choosing stock for investing online or through other channels.
One way to value a company is to look at its assets, which can be a long and difficult process. An easier way is by examining how those assets have been paid for — in cash, with debt, or with company equity. That’s what EV does, to determine the value of a company. This can be part of an investor’s fundamental analysis of a company.
Enterprise Value vs Market Capitalization
When considering the size and scale of a company, one place investors begin is by looking at its market capitalization, which can be determined by multiplying the total number of outstanding shares (stock that’s held by investors) and the current price per share.
Market capitalization is essentially an estimate of a company’s overall value at a particular period in time. But market cap doesn’t tell the whole story. That’s where calculating the company’s EV can help you arrive at a more accurate representation of a firm’s value. EV differs from market cap in that it factors in cash and debt: two important factors for evaluating a company’s value.
Because of how it’s calculated, a company’s EV can be negative if it holds more in cash and cash equivalents than the combined total of its market cap and debt. In such an instance, a company may be an attractive target for takeover. This may also be valuable information to consider when trading stocks online.
The Enterprise Value Formula
The EV calculation draws on a combination of a company’s financial statements and current market share price, and includes the following factors.
Components of the EV Formula
The components of the EV formula are important to understand.
• Market cap is the total value of a company’s outstanding common stock: the number of shares multiplied by share value.
• Debt refers to the combined long- and short-term obligations that the company owes its lenders and bondholders. If you don’t have access to the market value of debt, then you can use the book value of debt. This is added to the EV, because anyone who bought the company outright would be responsible for the debt.
• Preferred equity may need to be factored in, if the company issued any. These shares count as equity in the equation, though they’re not included in the company’s market capitalization.
• Minority interest refers to equity ownership of any subsidiary where the company owns less than 50%.
• Cash and cash equivalents are the liquid assets on a company’s balance sheet. In the formula, this element is subtracted, because an acquirer of the company would use these assets to pay off some of the acquisition cost.
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How to Calculate EV
The EV calculation comes in two forms, the simple and the extended versions:
The simple EV formula:
EV = Market Capitalization + Market Value of Debt – Cash and Equivalents
The extended formula:
EV = Common Shares + Preferred Shares + Market Value of Debt + Noncontrolling (minority) Interest – Cash and Equivalents
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How to Calculate Enterprise Value
To calculate EV, you have to go through several steps. First, calculate the company’s market cap by multiplying the company’s share price by the number of shares on the market. Then add in the value of any preferred shares, minority stakes in subsidiaries, along with any outstanding debt.
From that number, subtract the company’s cash and cash equivalents. These could be the company’s total cash, Treasury bills, certificates of deposit (CDs), drafts, money orders, commercial paper, marketable securities, money market funds, or short-term government bonds. The number you’re left with is the company’s enterprise value.
Enterprise Value Calculation Example
If you wanted to look up the EV for hypothetical Company XYZ, start with its market cap. Assuming the hypothetical company had 100,000 shares, worth $100 per share, that would give it a market cap of $10 million.
Then you’d check its financial statements. Let’s say the company has issued $2,500,000 in bonds and taken out $2,500,000 in bank loans. It also owns a $1 million stake in another company that’s integral to its operations. That’s a total of $6 million in debt added to the company’s EV calculation.
But on its balance sheet, it’s holding cash reserves of $4 million, which is subtracted from the EV, bringing the enterprise value to $12 million.
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Why Enterprise Value Matters for Investors
Investors could use EV for a number of reasons, such as anticipating whether or not a company is a takeover target. In most acquisitions, the acquirer will often pay a premium to the stock’s current price. This is because EV is also a shorthand for the effective cost of buying a company.
But most investors use EV in context. They do this by creating ratios that use EV with other key metrics, such as earnings before interest, taxes, depreciation, and amortization (known as EBITDA), to gain insights into the condition and the prospects of a given company.
Financial Ratios Using EV
One of the most common uses of EV is in combination with other metrics and financial ratios. One of these is the EV-to-sales ratio, also known as EV/sales. Many investors prefer this ratio to the price/sales ratio, because it factors in the debt a company must repay. Investors see companies with low EV/sales multiple as possibly undervalued.
Another valuable measure is the EV-to-EBITDA ratio. While EBITDA is a valuable metric, it omits many of the costs of running a business. So investors use the EV/EBITDA ratio to compare a company’s value against its cash earnings, making it useful when comparing companies within the same sector.
Limitations of Using Enterprise Value
EV can tell investors a lot about a company, but it comes with its own blind spots. Because of how it factors in debt, investors should examine the ways the company uses debt.
An oil company, for example, may carry heavy loads of debt to buy property and equipment, as part of how it does business. But for a company in another industry, debt may point to revenue shortfalls, or other flaws. This is one reason why EV works well when comparing companies in the same field, but becomes less reliable when considering companies with different business models.
The Takeaway
Enterprise value, or EV, is an important calculation for determining a company’s total value, including its cash and its debts. Investors look to it to determine how likely a company is to be acquired, and to compare competing companies in the same industry.
But EV, because of how it factors in debt, can be misleading. This is because different companies in different industries use debt for different reasons. Most investors use EV in concert with other metrics, such as EBITDA or sales, to gain insights into the performance and possibilities of a given stock.
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FAQ
What is a negative enterprise value?
A company’s EV can be negative if its market cap and debt are of a lower value than the value of what it holds in cash and cash equivalents.
Why is cash subtracted from enterprise value?
In the EV formula, cash and cash equivalents on a company’s balance sheet are subtracted, because an acquirer of the company would be able to use those assets to pay down the acquisition cost.
How does debt affect enterprise value?
When calculating EV, outstanding debts are added to the overall value of the company.
What is the enterprise multiple?
The enterprise multiple is a metric that compares EV to its EBITDA, to help investors determine if the company is overvalued or undervalued versus its peers.
How does enterprise value differ from book value?
EV measures the value of a business, adding the value of its debt and subtracting the value of its cash, while book value presents the value of a company based on total assets minus total liabilities.
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