Equity Value vs Enterprise Value Multiples

Difference Between Equity and Enterprise Value

Equity value of the company is of two types: market equity value which is the total number of shares multiplied by market share price and the book equity which is the value of assets minus liabilities; whereas, enterprise value is the total value of equity plus debt minus the total amount of cash the company has – this roughly gives an idea about total obligation a company has.

This is one of the most common valuation topics that cause confusion in Equity Research and Investment Banking. In most basic terms, Equity Value is the value only to the shareholders; however, Enterprise value is the value of the firm that accrues to both the shareholders and the debt holders (combined).

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Source: Equity Value vs Enterprise Value (wallstreetmojo.com)

What is Equity Value?

Equity value is simply the value of a firm’s equity, i.e., the market capitalization of the firm. It can be calculated by multiplying the market value per share by the total number of shares outstandingTotal Number Of Shares Outstanding Outstanding shares are the stocks available with the company's shareholders at a given point of time after excluding the shares that the entity had repurchased. It is shown as a part of the owner's equity in the liability side of the company's balance sheet.read more.

For example, let’s assume Company A has the following characteristics:

Company A	Amount
Sharers Outstanding	$ 1,000,000
Current Share Price	$ 50.0

Based on the formula above, you can calculate Company A’s equity value as follows:

= $1,000,000 x 50
= $50,000,000

However, in most cases, this is not an accurate reflection of a company’s true value.

What is Enterprise Value?

Enterprise value considers much more than just the value of a company’s outstanding equity. It tells you how much a business is worth. Enterprise value is the theoretical price an acquirer might pay for another firm, and is useful in comparing firms with different capital structures since the value of a firm is unaffected by its choice of capital structure. To buy a company outright, an acquirer would have to assume the acquired company’s debt, though it would also receive all of the acquired company’s cash. Acquiring the debt increases the cost of buying the company, but acquiring the cash reduces the cost of acquiring the company.

Enterprise Value = Market value of operating assets
Equity Value = Market value of shareholders’ equity

Enterprise Value Vs Equity Value Diagram

Net Debt – Net debt is equal to total debt, less cash, and cash equivalents.

When calculating total debt, be sure you include both the long-term debt and the current portion of long-term debtThe Current Portion Of Long-term Debt Current Portion of Long-Term Debt (CPLTD) is payable within the next year from the date of the balance sheet, and are separated from the long-term debt as they are to be paid within next year using the company’s cash flows or by utilizing its current assets.read more or short-term debt. Any in-the-moneyIn-the-money The term "in the money" refers to an option that, if exercised, will result in a profit. It varies depending on whether the option is a call or a put. A call option is "in the money" when the strike price of the underlying asset is less than the market price. A put option is "in the money" when the strike price of the underlying asset is more than the market price.read more (ITM) convertible debt is treated as if converted to equity and is not considered debt.
When calculating cash and equivalents, you should include such balance sheet items as Available for Sale Securities and Marketable SecuritiesMarketable Securities Marketable securities are liquid assets that can be converted into cash quickly and are classified as current assets on a company's balance sheet. Commercial Paper, Treasury notes, and other money market instruments are included in it.read more,
The market value of debt should be used in the calculation of enterprise value. However, in practice, you can usually use the book value of the debt.

Let me explain it with an example. Consider the same company A and another company B having the same market capitalization. We assume two scenarios, 1 and 2.

Calculate Enterprise Value for Scenario 1.

Scenario 1	Company A	Company B
Debt	$20.0	$0.0
Cash	$0.0	$0.0

Enterprise Value for Company A is Market Capitalization ($50 million) + Debt ($20 million) – Cash and Short term investments ($0) = $70 million. EV for Company B is Market Capitalization ($50 million) + Debt ($0) – Cash and Short term investments ($0) = $50 million.

While both companies have the same market capitalization, the better buy is Company B or the company with no debt.

Now, consider scenario 2

Scenario 2	Company A	Company B
Debt	$20.0	$20.0
Cash	$5.0	$15.0

Calculate Enterprise Value for Scenario 2. EV for Company A is Market Capitalization ($50 million) + Debt ($0) – Cash and Short term investments ($5 million) = $45 million. EV for Company B is Market Capitalization ($50 million) + Debt ($0) – Cash and Short term investments ($15 million) = $35 million.

While both companies have the same market capitalization and no debt, the better deal is Company B, as you would assume $15 million in cash upon purchase of the company.

Equity Value vs. Enterprise Value Infographics

What is Equity Value Multiple?

The equity value multiples have both the numerator and the denominator as the “Equity” measure. Some of the multiples of Equity value multiples are as per below.

Numerator – Equity Value is the Price per share that shareholders are expected to pay for a single share of the company under consideration.

Denominator – Operating parameters like EPS, CFS, BV, etc. equity measures. For example, EPS – Earnings per share, and it reflects the profit per share that accrues to the shareholders.

PE MultiplePE Multiple The price to earnings (PE) ratio measures the relative value of the corporate stocks, i.e., whether it is undervalued or overvalued. It is calculated as the proportion of the current price per share to the earnings per share. read more – This ‘headline’ ratio is, in essence, a payback calculation: it states how many years’ earnings it will take for the investor to recover the price paid for the shares. Other things being equal, when comparing the price of two stocks in the same sector, the investor should prefer the one with the lowest PE.
PCF Multiple – It is a measure of the market’s expectations of a firm’s future financial health. This measure deals with cash flow, the effects of depreciation and other non-cash factors are removed.
P/BV Multiple – Useful measure where tangible assets are the source of value generation. Because of its close linkage to return on equity (price to bookPrice To Book Price to Book Value Ratio or P/B Ratio helps to identify stock opportunities in Financial companies, especially banks, and is used with other valuation tools like PE Ratio, PCF, EV/EBITDA. Price to Book Value Ratio = Price Per Share / Book Value Per Share read more is PE multiplied by ROE), it is useful to view price to book value together with ROE.
P/S Multiple – Price/sales can be useful when a company is loss-making, or its margins are uncharacteristically low (distressed firms)
PEG Multiple – PEG ratioPEG Ratio The PEG ratio compares the P/E ratio of a company to its expected rate of growth. A PEG ratio of 1.0 or lower, on average, indicates that a stock is undervalued. A PEG ratio greater than 1.0 indicates that a stock is overvalued.read more is used to determine stock’s value while taking into account earnings growth. The enterprise value multiples have both the numerator and the denominator as “Pre Debt” and “Pre-Equity” measure. Some of the multiples of Enterprise value multiples are as per below.

What is Enterprise Value or EV Multiples?

Numerator – Enterprise value is primarily a pre-debt and pre-equity measure as EV reflects values both to the Debtors as well as Shareholders’.

Denominator – Operating parameters like Sales, EBITDA, EBIT, FCF, Capacity are pre-debt and pre-equity measures. For example, EBITDA – Earnings “before” Interest tax depreciation and amortization; this implies that EBITDA is the measure before the debtors and shareholders are paid off and likewise.

EV/EBITDA Multiple – Measure that indicates the value of the overall company, not just equity. EV to EBITDAEV To EBITDA EV to EBITDA is the ratio between enterprise value and earnings before interest, taxes, depreciation, and amortization that helps the investor in the valuation of the company at a very subtle level by allowing the investor to compare a specific company to the peer company in the industry as a whole, or other comparative industries.read more is a measure of the cost of a stock, which is more frequently valid for comparisons across companies than the price to earnings ratio. Like the P/E ratio, the EV / EBITDA ratio is a measure of how expensive a stock is.
EV/Sales Multiple – EV/sales is a crude measure, but least susceptible to accounting differences. It is equivalent to its equity counterpart, price to sales, where the company has no debt.
EV/EBIT Multiple – EBIT is a better measure of ‘free’ (post-maintenance capital spending) cash flowCash Flow Cash Flow is the amount of cash or cash equivalent generated & consumed by a Company over a given period. It proves to be a prerequisite for analyzing the business’s strength, profitability, & scope for betterment. read more than EBITDA and is more comparable where capital intensities differ.
EV/FCF Multiple – EV/FCF is preferable to EV/EBITDA for comparing companies within a sector. Comparing across sectors or markets where companies have widely varying degrees of capital intensityCapital Intensity Capital intensity refers to the infusion of massive investment into the business setup or production of goods or services. It includes enormous capital investment in the fixed assets like land, plant, building, equipment, infrastructure, etc.—for instance, petroleum plant and automobile manufacturing unit.read more
EV/Capacity – Core EV/units of capacity (such as tonnes of cement capacity) or another revenue-generating unit (such as subscribers).

Equity vs. Enterprise Value Comparative Table

Equity Value	Enterprise Value (EV)
Express the value of shareholders’ claims on the assets and cash flows of the business	Cost of buying the right to the whole of an enterprise’s core cash flow
Reflects residual earnings after the payment to creditors, minority shareholders & other non-equity claimants	Includes all forms of capital – equity, debt, preferred stock, minority interestMinority Interest Minority interest is the investors' stakeholding that is less than 50% of the existing shares or the voting rights in the company. The minority shareholders do not have control over the company through their voting rights, thereby having a meagre role in the corporate decision-making.read more
Advantages of Equity Value • More relevant to equity valuations • More reliable • More familiar to investors	Advantages of Enterprise Value •Accounting policy differences can be minimized • Avoid the influence of capital structure • Comprehensive • Enables to exclude non-core assets • Easier to apply to cash flow

Overvalued or Undervalued?

There are primarily two ways in which the fair valuation of the company can be arrived at using the relative valuation technique. They are multiple historical methods and sector multiple methods.

#1 – Historical Multiple Method

The common approach is to compare the current multiple to a historical multiple measured at a comparable point in the business cycleBusiness Cycle The business cycle represents the expansion and contraction of the economy that occurs due to ups and downs in the gross domestic product (GDP) of a country. It is experienced over the long term and goes parallel with the natural growth rate.read more and macroeconomic environment.

The interpretations are relatively simpler if we create the Price to Earnings Graph. As noted above, the Foodland Farsi current PE ~ 20x; however, the historical average PE was closer to 8.6x.

Currently, the market is commanding $20/EPS (defined as PE); however, in the past, this stock was trading at $8.6/EPS. This implies that the stock is overvaluedStock Is Overvalued Overvalued Stocks refer to stocks having more current market value than their real earning potential or the P/E Ratio. Overvaluation of stocks might occur due to illogical decision making or deterioration in a Company’s financial health. read more with PE = 20x when compared with historical PE = 8.6x, and we may recommend a SELL position on this stock.

#2 – Sector Multiple Method

In this approach, we compare current multiples to those of other companies, a sector, or a market. Below is a hypothetical example to explain this methodology.

IT Sector	PE
HCL Tech	20.2
TCS	22.7
Wipro	25.8
Mahindra Satyam	21.1
NIIT	16.0
Patni	18.3
Sector Mean	20.7
Infosys	17.0

From the table above, the average PE multiple for the IT sector is 20.7x. However, the company under consideration – Infosys, is trading at 17.0x. This implies that Infosys is trading below the average sector multiple, and a BUY signal is warranted.

Comparable Company Analysis

Below is a typical relative valuation table that an analyst is expected to produce as a part of the research. The comparison table contains the sector companies and their respective operating and valuation parameters. In most cases, the parameters contained in the table are as per below

Company Name
Latest Price
Market Capitalization
Enterprise Value
EBITDA
Net Income
Valuation Methodologies like PE, EV/EBITDA, P/CF, etc.;
Trailing & Forward Multiples are Calculated (2-3 years of multiples)

Mean & Median Multiple values

The procedure to calculate a multiple can be simply summarized as below

Though the above example is simple, however, for applying the same in real-life scenarios, one needs to establish the value and the value driver and make several adjustments to it.

In my next valuation series, I have discussed the nuts and bolts of Comparable Company Analysis and Sum of Parts valuationSum Of Parts Valuation Sum of the Parts Valuation is a valuation method wherein each of the subsidiary or segment of a Company is separately valued & then all of them are added together to estimate the business’s total value. read more.

Conclusion

As we note from the above article that both tools are important from the point of view of Valuations. Equity Value is the value only to the shareholders; however, Enterprise value is the value of the firm that accrues to both the shareholders and the debt holders (combined).

In each company/sector, however, there are 3-5 multiples (Enterprise value or Equity value or both) that can be applied. It is more important for you to know the usage and application of each multiple.

Equity Value vs. Enterprise Value Video

Comments

Jon says

Thanks for the article.

When deriving Equity Value from Enterprise Value, should the book value or target value of debt be used?

- Dheeraj Vaidya says
  
  Hey Jon, Book value is used in this EV to Equity formula.
  
  thanks,
  Dheeraj
  
  - Jon says
    
    Why don’t we use target value of debt?
    
    - Dheeraj Vaidya says
      
      this is because we are trying to value the company “today”. If you are trying to find the target price of the stock in say 1 year from today, then target value of debt (after 1 year, your estimate) can be used.
      
      Thanks,
      Dheeraj
      
kanika says

I was once asked in the interview ” Why don’t we deduct fixed assets and current assets while calculating EV as we deduct cash balance”. What is the correct answer according to you?

- Dheeraj Vaidya says
  
  Hi Kanika,
  
  EV = Equity + Debt – Cash. The total enterprise value is the value of the total firm (found by FCFF – DCF). In our projections of FCFF we take changes in Fixed Assets and changes in WC (except cash). FCFF doesn’t take care of Cash in the Balance Sheet. Hence, Cash is reduced, while Fixed Assets and other current assets are not deducted.
  
  Thanks,
  Dheeraj
  
Soumen says

What is – ve ev and what does it signify ?

- Dheeraj says
  
  Hi Soumen,
  
  EV = Equity + Debt – Cash. Negative EV can come when either Equity value is low due to lower trading prices, no presence of Debt or low debt and High Cash in the Balance Sheet. Generally, negative EV is not a problem as this situation can come due to very high Cash in the balance sheet. EV is used largely for finding potential M&A as there can be some companies whose shares may got a beating and may be trading at low EV.
  
  Thanks,
  Dheeraj
  
Andrew says

Hi

Please send me your email address so I can contact you direct

Andrew says

Is the market approach valuation methodology the same as the company comparables method just a different name ?

- Dheeraj says
  
  You are right Andrew. Relative Valuations, Market approach valuations or Company comparables – all mean one and the same!
  thanks,
  Dheeraj
  
  - Andrew says
    
    Thanks for that info.
    With regards to your Box IPO and Alibaba IPO model you have used quarterly income statements. Why have you used these together with the year end income statements? If I want to value a company already listed surely I can just use its year-end financials ?
    
    - Dheeraj says
      
      Hi Andrew, yes you can just use the year end financials. in the Box IPO and Alibaba IPO model, i also had quarterly income statements as one approach could be to forecast the income statements on a quarterly basis. Forecasting on a quarterly basis is a robust approach to modeling, however, it takes lot of time. One limitation of quarterly forecast could be that all the financial statements data (Is, BS, CFs) and other revenue drivers may not be available.
      Best,
      Dheeraj
      
Madhu says

thank you for sharing of knowledge

sonal says

Why do we take into account both Mean &Medain?

- Wall Street Mojo says
  
  Hi Sonal, Mean provides us with the average multiple. Now take an exaggerated case where there are outlier companies who PE are very high (250x) of say very low (PE of 1-2x). If we take these into consideration, these outliers will skew the global average of the overall industry and should be best avoided (as they are not typical of the sector). Median just provides the exact middle point of the PE and help us avoid the problem of such outliers.
  
  - sonal says
    
    Great! So we can say median gives better picture & more reliable to take decisions for analysts and others. On other hand mean gets effected by extremes.
    
Hiten says

Very simple and lucid. great!!!

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Equity Value vs Enterprise Value