A company’s enterprise value (EV) is an important point of understanding for investors and is a fundamental learning point in many business schools, as well as CFA level I and II. The EV figure is an all-encompassing measure of the market value of all capital and other claims against the company. The detailed formula for EV can be seen below for investors to digest as we walk through the logic, components, and its use in valuations.
|Enterprise Value (EV)||= market value of Equity|
|+ market value of Debt|
|+ market value of Preferred Shares|
|+ market value of Minority Interest|
|– market value of Short-term Investments|
|– Cash & Equivalents|
The Logic of Enterprise Value
Enterprise value is concerned with valuing the total capital of the business, both debt and equity capital, with equity capital also taking into account the non-controlling interest of subsidiaries. Because of its focus on measuring the total value of the company, enterprise value is also referred to as takeover value, as it signifies the amount an acquirer would have to pay to purchase all the capital of the business.
Cash and short-term investments are subtracted in the formula for enterprise value because they are not operating assets and could essentially be immediately sold upon acquiring the business.
Side Note: Enterprise value is different from the invested capital figure in the ROIC calculation because it is using market based valuation figures whereas the invested capital in ROIC calculations is based on balance sheet figures from the financial statement.
The Components of Enterprise Value
The various components needed to calculate enterprise value are all based on market value which can be notably different than the carrying value seen on the balance sheet of the financial statements for critical items such as equity, debt, and preferred shares.
Market Value of Equity – Also referred to as market capitalization, the market value of equity can be calculated by taking the number of shares outstanding and multiplying them by the current share price.
Market Value of Debt – Finding the market value of debt is more difficult because bond prices are not as widely quoted as stock prices. Financial data providers such as Bloomberg will readily provide the latest prices for all the outstanding bond issues of a company but these subscription services can get pricey. The book value of debt on the balance sheet can be a good approximation for market value. However, if interest rates have changed significantly or if the company’s risk profile has changed, the market value could be very different than book value.
Sophisticated investors looking to get a more precise figure for the market value of debt can adjust the book value of debt to market value by treating all the company’s debt as one giant maturing bond. Using the weighted average term to maturity and weighted average coupon rate disclosed in the notes to the financial statements, one can use a present value formula taking into account the current risk free rate and adding an appropriate spread for the company’s risk or credit rating.
Market Value of Preferred Shares – Given the price of preferred shares are widely quoted on every finance website, finding the market value of preferred shares is relatively easy. The quoted price for each preferred share can be multiplied by the amount of preferred shares outstanding. It is important to note that there might be multiple classes of preferred shares outstanding for a single company, so be sure you are calculating each separately.
Market Value of Minority Interest – Minority interest represents the value not owned of subsidiary companies which are being consolidated into the financial statements. The amount reported on the balance sheet is based on historic book value but can be used as an approximation if it is not possible to value the subsidiary separately.
Side Note: As a reminder, under accounting standards, all the assets and liabilities of subsidiaries are generally consolidated if the parent company is deemed to have control (ie. over 50% voting rights). The value of the subsidiary’s equity not owned by the parent company is being reported as a minority interest liability as it is owned by a 3rd party. Once again, these are all book values and not market values.
Market Value of Short-term Investments – Short-term investments are carried at fair value on the balance sheet with their profit (loss) fluctuation put through the income statement. As such, the market value of short-term investments can accurately be taken straight from the balance sheet.
Cash – Needless to say, cash is already at market value on the balance sheet and is normally included in full within the calculation of enterprise value.
Enterprise Value in… Valuations
Since enterprise value is concerned with the market value of all the capital claims on the business, it can be used in valuations where the cash flows or profits being valued are before the cost of capital. The most common valuation metric that incorporates enterprise value is the EV-to-EBITDA multiple, which divides enterprise value by earnings before interest, taxes, depreciation and amortization.
Even within regular equity valuations, components of enterprise value will surface. My favorite intrinsic value calculations are done as a discounted cash flow which present values net operating profit less adjusted taxes (NOPLAT). As NOPLAT is before the cost of capital, the calculation yields an estimate enterprise value from which items such as debt and preferred equity are then backed out to leave investors with the their estimated intrinsic value of equity. While book value is often used for simplicity, backing out the market value of these items would be preferred.
For investors interested in a pre-built financial model where they can punch in the financial data of any company of interest, they can check out our financial model and valuation template!
Understanding the concept of enterprise value is central to understanding the value of a company. Enterprise value looks at the market value of all the capital in the business less any cash and short-term investments. The components of enterprise value surface in many valuation methods and are central learnings for every investor.