What is Enterprise Value (EV)?
Enterprise value is the total value of a company including all debt. Enterprise Value is often thought of as the total cost to an investor who would purchase, or takeover, the company.
How is Enterprise Value Calculated?
Calculating a company’s enterprise value is easy, and the value is given on many finance sites today. But it is important to know what the variables are in the formula for enterprise value.
The formula for enterprise value is:
EV = market cap + total debt – cash:
Enterprise Value is the total of the company’s market capitalization (the cost it would take to buy every share), plus the company’s total debt (both short and long term debt on the company’s balance sheet), and then subtract total cash the company has (because if you were taking over a company, you would also get the company’s cash, and buying cash with cash effectively nets out).
To find a company’s Enterprise Value, look at any major financial site and it will probably be listed. For example, shown below is Intel’s Enterprise Value, as shown on Seeking Alpha:
But it is always good to check these numbers and verify them (or at least know how to verify the numbers) yourself.
How was Intel’s Enterprise Value calculated above?
First, start with calculating the company’s market cap. This is shown above, but can also be calculated yourself by taking the current share price, multiplied by the number of shares outstanding.
As I write this today, Intel’s share price is $48.92
And Intel currently has about 4.253 billion shares outstanding. This number can be found in the company’s latest 10-q quarterly filing.
If we multiply the share price by the number of shares outstanding, we get $208.056 billion.
Next, we need to add the company’s debt.
Intel shows on their balance sheet $2.254 billion in short term debt and $36.093 billion in long term debt, for a total of $38.347 billion :
Then, subtract cash on the company’s balance sheet:
What exactly you subtract for “cash” can be subjective. You will notice that in the image of Intel’s Market Cap and Enterprise Value from Seeking Alpha above, that Seeking Alpha subtracted not only cash and cash equivalents, but also a few other current assets such as short-term investments and trading assets that were on Intel’s balance sheet.
That is not wrong, but you as the analyst may want to be sure you are confident in what exactly you are subtracting in your formula to determine a company’s enterprise value.
Other Items To Calculate Enterprise Value
Intel’s numbers are pretty straightforward, but some company’s may have other items on their balance sheet that need to be added in to determine the company’s enterprise value.
For example, if a company has issued preferred shares, you will need to add the value of the preferred shares as well to the debt.
For example, if Intel had $5 billion in preferred shares outstanding, you would add $5 billion to your calculated enterprise value above.
What is the Difference Between Enterprise Value and Market Capitalization?
The formula for Enterprise Value of a company includes debt and equity, whereas the market cap of a company only considers the value of the company’s equity.
Many investors prefer to use Enterprise Value because it makes it easier to compare companies with different capital structures.
For example, notice above that Intel’s Market Capitalization and Enterprise Value where relatively similar. $200 billion compared to $220 billion.
Now, look at Ford, whose market cap and enterprise value are very, very different:
So, if you are an investor and considering either putting your money into Intel or Ford, this should be a big warning sign that these companies are very different.
Most of Intel’s value is in the company’s equity.
Most of Ford’s value is in its debt.
So, it would be very wrong to use a figure like P/E, or Price to Earnings Ratio to compare these companies, since the “P” in the P/E formula uses market cap, of which Ford has very little. (This is why it looks like Ford has a very low P/E ratio today, but in reality, it is probably not cheap at all when you compare Enterprise Value to Earnings!).
As I type this today, Ford’s P/E ratio is very low, around 6. If all you did was look at that ratio, you may be inclined to believe that Ford stock is very “cheap”.
However, as we see above, Price or market cap, is a very poor way to determine Ford’s value. You should instead use enterprise value.
Ford’s EV/Enterprise ratio (discussed in more detail below) is 27.1 – hardly cheap at all!
This is just another example on how it is dangerous to overweight any single value when evaluating a company. If all you did was screen stocks based on P/E ratio, you may end up buying a lot of companies with significant debt, who may not be that “cheap” at all!
How is Enterprise Value Used to Evaluate a Stock?
There are a few common ratios that enterprise value is used in to help analyze a stock.
Enterprise Value to EBITDA
EBITDA is Earnings Before Interest, Taxes, Depreciation, and Amortization. It is commonly used as a way to calculate a form of cash flow of a business.
These days, a company’s EBITDA is widely published, for example shown below is from Seeking Alpha:
However if you need to calculate it out, the items to calculated EBITDA are found on the company’s income statement and cash flow statement.
The ratio of a company’s enterprise value to EBITDA, or EV/EBITDA will be a number that you want to compare with other potential investments you are considering.
The lower a company’s EV/EBITDA, the cheaper the company is.
For example, Intel’s EV/EBITDA ratio is currently 5.7. Intel’s competitor, AMD or Advanced Micro Devices, currently has an EV/EBITDA ratio of 82.
That means that Intel is much cheaper in terms of the company’s cash flows than AMD. Remember, never invest based on one metric alone. EV/EBITDA does not take into account growth, so this tells us that investors are anticipating AMD to grow much faster than Intel going forward. It is up to you as an investor to determine whether the value of Intel outweighs the potential for growth (but a much higher multiple) of AMD.
Using EV/EBITDA to Calculate a “Cash on Cash” Yield
Also, many investors flip the EV/EBITDA ratio to determine a “cash on cash yield” of a stock. Remember, Enterprise Value is a calculation of how much money it would take to buy the entire operations of a company, and EBITDA is commonly thought of as a calculation of cash flows. So, we can use these figures to calculate a form of “yield” on our investment.
For Intel, we calculated a EV/EBITDA ratio of 5.7. If we flip that to be 1/5.7, we get 0.175, or 17.5%. This tells us that if we purchased all of Intel today for $220 billion, we would receive 17.5% of that in EBITDA, or cash flow, each year. Some may call this a 17.5% EBITDA yield.
That is a very good return! Not let’s look at AMD. Recall that its EV/EBITDA ratio was 82. If we take 1/82, we get 0.0121, or 1.21%. This tells us that if we purchased AMD today, we would be getting a 1.21% return on our investment. That is significantly lower than the return Intel provides! So, if we are buying AMD, we are betting on growth. We are accepting a lower return today in exchange for the prospects of much higher future numbers.
Likewise, if we buy Intel today, we are buying it for its cash flow and earnings today, but should not expect as much growth in the numbers.
A value investor would strongly favor Intel here, whereas a growth investor may like the prospects of AMD more.
Bottom Line
Using enterprise value as a measurement of a company’s value can be a much more accurate way to compare different companies. Enterprise value takes into account a company’s capital structure, including its debt.
