Market Cap vs Enterprise Value | Same or Different?

Market Cap vs Enterprise Value

Probing the value of a company plays a critical role in any sector of the finance industry. A key reason is that it helps the investors to not only make better investment decisions but provide them with a comprehensive view for acquisition assessments and budgeting purposes. Also, it enables investors and analysts to forecast and predict the future earnings of a company.

Thus, it becomes even more important to use the right metrics that can be used to measure the value of a company, given the wide-spread financial metrics. However, the most frequently used parameters are Market Cap and Enterprise Value.

Market Cap vs Enterprise Value

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Let us have a look.

What is Market Cap?


Also known as market cap is the market value of a company’s stock. This financial metric assesses the value of a business based solely on the stock. Therefore, to find the market cap of a company, one can multiply the number of shares outstanding by the current share price of the stock.

The market capitalization formula is as follows;

Market capitalization = shares outstanding x price per share

Where:

  1. Share outstanding = the total number of common stocks issued by a company excluding the preferred shares.
  2. Price per share = the current price of the stock in the individual listed market such as NSE, BSE, NYSE, and NASDAQ, etc.

Market Cap Calculation


Please have a look at the below table for Market Capitalization calculations.

market-capitalization

source: ycharts

Market Capitalization is Shares Outstanding (1) x Price (2) = Market Cap (3)

Apple has a total of 5.332 billion shares outstandingShares OutstandingOutstanding 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, with each share trading at the current market price of $110.88 (Nov 9th closing). Consequently, its market capitalization is worth $591.25 billion (5.332*$110.88), based on the information given above.

The important thing to note here is that the market capitalization of a company keeps changing with the fluctuation in the share price. This means that the market cap of the company increases and decreases with the rise and fall of the stock price.

Where to find Market Cap information?

Determining the value of a company, the students or entry investors can find detail information regarding the current share price of a company, shares outstanding, enterprise value, etc. on various websites such as Yahoo! Finance, Google Finance, Bloomberg, and many other websites. One can search the company by filling the company’s name or ticker in the search engine to get the information.

You can also consider making access to Ycharts for the same.

Price vs. Market Capitalization


The investors should not be carried away with the price per share because it is one of the common misconceptions regarding a good indicator of the size of a company.

For instance, if a company ABC has 7.78 billion shares outstanding and the current market price of its stock is $80 per share, it will have a market capitalization of $622.4 billion. That is to say, the market cap of company ABC is higher by $29.7 billion as compared to Apple’s market cap of $592.7 billion.

Moreover, this larger market cap for ABC was despite its current share price is lower than that of Apple, as stated above. Thus, a company with a higher share price does not necessarily mean that the company is worth more than the company with a lower stock price.

Top 12 companies by Market Cap


Below is the list of top 12 companies by Market Capitalization. We note that Apple is on top with a market capitalization of close to $590billion, where Google is second with a market cap of $539.7 billion.

top-12-market-capitlization-firms

source: ycharts

Market Capitalization and Investment rationale

The company with a lower market cap provides investors with greater growth opportunities in the future, while the company with the higher market cap is entitled to carry less risk regarding price volatility and carry a sustainable growth rate Sustainable Growth Rate Sustainable Growth Rate (SGR) signifies how much a company can grow without relying on external capital infusion and is calculated using the return on equity and multiplying it by the business retention rate. Formula = retention rate * return on equityread morewith a good return on investment. The chart below shows the market cap for the largest companies in the world.

Why is Market Cap important?


  1. It helps investors and analysts to examine the cost of buying the entire shares of a company in the case of a merger or acquisition.
  2. This financial metric lend a hand determining factors in stock valuation.
  3. It represents the market view of a company’s stock value.
  4. Market cap enables investors to make a potential investment in a company based on the market cap size, such as large-cap, medium-cap, and small-cap.
  5. It facilitates investors in identifying peers within the same sector or industry.  Also, read comparable comps.

Thus, it is evident from the above information and examples that market capitalization is the function of both the price per share and the shares outstanding. However, it completely ignores the debt portion of a company that plays an equally important role in the overall valuation of the company on the purchase by the new owners. As such, the latter part of this article will briefly highlight the Enterprise Value that provides a clear picture of the real value of a company. Let us have a look.

What is Enterprise Value?


Enterprise Value, on the other side, is a more comprehensive and alternative approach to measuring a company’s total value. It takes into account various financial metrics such as market capitalization, debt, minority interest, preferred shares, and total cash and cash equivalents to arrive at the total value of a company. Although the minority interest and preferred shares are most of the time kept on zero effectively, this may not be the case for some companies.

In simple words, enterprise value is the total price of buying a company as it calculates the accurate value of a company.

The formula to calculate EV would be;

Enterprise Value = market value of common stock or market cap + market value of preferred shares + total debt (including long and short-term debt) + minority interest – total cash and cash equivalents.

enterprise value

Or

Enterprise Value = Market Capitalization + Debt  + Minority Shares + Preferred Stock – Total Cash and Cash Equivalents

top-enterprise-value

source: ycharts

However, it is considered that a company with more cash and less total debt in its balance sheetBalance SheetA balance sheet is one of the financial statements of a company that presents the shareholders' equity, liabilities, and assets of the company at a specific point in time. It is based on the accounting equation that states that the sum of the total liabilities and the owner's capital equals the total assets of the company.read more will carry an enterprise value less than its market capitalization. In contrast, a company with small cash and more debt on the balance sheet will have an enterprise value higher than its market capitalization.

For example, have a look at JPMorgan Chase. It’s cash, and cash equivalent are very high. This results in its enterprise value to be less than the market capitalization.

enterprise-value-can-be-less-than-market-cap

source: ycharts

Top 12 Enterprise Value Companies 


Below is a list of companies with top enterprise values.

top-enterprise-value-comp

source: ycharts

Why Enterprise Value is Important?


  1. A company with less or no debt remains an attractive buy option for investors due to the lower risk attached to it.
  2. A company with high debt and less cash carries a higher risk because the debt raises the costs, and therefore it remains less attractive to investors.

For example, two companies with the same market capitalization can fundamentally provide different enterprise value due to a high level of debt and low cash balances for one and low debt and high cash for the other. This is given in the table below.

 Market CapitalizationDebtCashEnterprise Value
Company A$10  billion$5.0 Billion$1.0 billion$14.0 billion
Company B$10  billion$2.0 billion$3.0 Billion$9.0 billion

From the above example, it is clear that Company A remains riskier as compared to Company B that due to higher debt, despite their market capitalization being identical. Therefore, the buyer will be more likely to acquire Company B, which has no debt.

Why Enterprise Value provides an accurate value for a company?


Digging further into enterprise valueEnterprise ValueEnterprise Value is a measure of a company's total value that spans the entire market rather than just the equity value. It includes all debt and equity-based ownership claims. This value, which is calculated as the market value of debt + market value of equity - cash and cash equivalents, is particularly relevant when valuing a takeover.read more unveils that it computes the value of the assets that allow the company to produce its product and service. Hence one can say that it encompasses the economic value of a firm due to the fact that it takes into consideration the equity capital and debt obligation of an enterprise. A key aspect that includes the total debt and total equity is because these metrics enable the company to calculate EV ratios.

Also, look at Equity Value vs. Enterprise Value.

EV Ratios

: EV ratios help investors to provide key insights and comparisons between two companies that have large differences in capital structure and thereby make sound investment decisions.

There are quite a number of EV ratios. They include;

  1. EV/EBIT (Earnings before interest and tax)
  2. EV/EBITDAEV/EBITDAEV 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 (Earnings before interest, tax, depreciation, and amortization)
  3. EV/CFO (Cash from the operation)
  4. EV/FCF (Free Cash Flow)
  5. EV/Sales or Revenue
  6. EV/ Assets

For the purpose of this discussion, we will discuss the EV/EBIT Ratio.

EV/ EBIT

EV/ EBIT ratio assists the investors in finding out the enterprise multiple that remains a critical function in the purchase decision. Usually, the lower enterprise multiple is considered a better value of a firm in comparing the two different companies held for acquisitions.

In fact, the investors can get the earnings yield upon turning the ratio around that allows the investors to get to know earnings yield for a company. More often than not, a higher earning yield indicates a better value for a firm.

Let us compare two companies for better understanding this ratio and its implication on the decision- making process. For instance, company ABC has an enterprise value of 5 billion, and its earnings before interest and taxEarnings Before Interest And TaxEarnings before interest and tax (EBIT) refers to the company's operating profit that is acquired after deducting all the expenses except the interest and tax expenses from the revenue. It denotes the organization's profit from business operations while excluding all taxes and costs of capital.read more is $500 million, while company XYZ has an enterprise value of $5 billion and its earnings before interest and tax are $650 million.

Company ABC:

EV/ EBIT = $5.0 billion / $500 million = 10 multiple (5000/500)

EBIT/ EV = $500 million / $5.0 billion = 10% yield (500/5000)

Company XYZ:

EV/EBIT = $5.0 billion/ $650 million = 7.7 multiple

EBIT/EV = $650 million/ 5.0 billion = 13% yield

Investment rationale for EV/EBIT

The thumb rule says that lower enterprise multiple and higher earnings yields reflect better value for your money. Thus, in this case, if the investors will be willing to put their money into the company XYZ as it has a lower enterprise multiple and higher earnings yield.

Likewise, the value investors can calculate the other ratio. The thumb rule applies to all the EV ratios despite being large differences in the other financial metrics such as EBITDA, cash flow from operationsCash Flow From OperationsCash flow from Operations is the first of the three parts of the cash flow statement that shows the cash inflows and outflows from core operating business in an accounting year. Operating Activities includes cash received from Sales, cash expenses paid for direct costs as well as payment is done for funding working capital.read more, free cash flow, sales and revenue, and assets, while keeping the capital structure on neutral.

Thus, once the investors or value investors can find out the enterprise value, he or she can be in a better position to make his or her decision to go for acquisition or not. As such, EV can be considered critical financial metrics, calculating the enterprise value.

Market Capitalization vs. Enterprise Value


Market Cap Vs. Enterprise Value
Area of ComparisonMarket CapitalizationEnterprise Value
MeaningRefers to the market value of the shares outstandingRefers to the costs of acquisition, including the amount payable towards debt and Equity
FormulaNumber of shares outstanding (x) the current share priceMarket Cap + Debt + Minority Interest + Preferred shares – total cash & cash equivalents
PreferenceLess preferred due to its usages in theoretical calculation rather than practical to determine the value of a company.More preferred because it takes into consideration a number of factors to calculate the true value of a company.

Market Cap vs. Enterprise Value Video

 

Conclusion


Thus it is clear from the above examples that both the financial metrics have different approaches to identify the market value of the given company. Market capitalization is one side that helps the investors to find information regarding the company’s size, value, and growth; the enterprise value enables investors to measure the overall market value of a company at the other. However, the enterprise value is preferred more than the market capitalization metric due to the fact that it accurately determines the value of the company and helps the analysts to forecasts the company’s growth in the future by using the EV ratios, as stated in this article.

Reader Interactions

Comments

  1. Prashant says

    thanks this is the best site for clarifications and illustrations.

  2. Ravi Kumar Gupta says

    Thank you Sir. You explain the concepts so well. Keep it up.

  3. Anjani Mishra says

    I am Six Sigma Consultant supporting Investment Banking division of one of the largest financial institutions in the USA. IB not being my core domain, I was looking for an online site where these financial terms are explained in easy terms and was lucky enough to come across your blog. Reading your articles gives me enough confidence and knowledge while dealing with my lines of business at work. Thank you very much for creating this blog. Looking forward to come back and read more in future. Thanks again

  4. Pankaj Sonawane says

    Thanks Dheeraj for the article !!!

  5. PRABHAKAR BV says

    Your website simply great source for gaining and enhancing financial knowledge.

    Thanks

  6. hari says

    If EV is higher than MARKET Cap than is it advisable to buy the shares of the company or not.

    • Dheeraj Vaidya says

      Hi Hari, if EV is greater than Market Capitalization, then it does not necessarily mean anything from a valuation point of view. It only means that there is debt that increases the EV of the firm. For valuations, you need to consider multiples like EV/EBITDA, PE Ratio, P/BV ratio etc.
      thanks,
      Dheeraj

      • hari says

        ok thank you. Plzz try to come up with a paid afforadble Excel stock analyzerr .

        Thank You

        • Dheeraj Vaidya says

          hi Hari, thanks for your advise. Will have to check on how this could be done. will update you on this.

  7. Shiven Agarwal says

    Hi dheeraj,

    Its simply great whenever I visit your site, I become more knowledegable
    Thanks for your awesome explaination.

  8. Manas says

    Thanks

  9. Sameer Sharma says

    Very well explained. This has been very helpful.
    Is it possible for me to contact you to take your opinion on a particular finance topic? Would be grateful if you could let me know.

    • Dheeraj Vaidya says

      Thaks Sameer. You may contact me on the email that I sent you earlier.

  10. Pranayy says

    I am your fan dheeraj vaidya

  11. PRAKASH RAVAL says

    Dear Sir

    Nicely explained Enterprise value and Market capitalization.

    Regards
    Prakash Raval

  12. aala says

    GOOD WORK Dheeraj

  13. Ginno says

    That is a good approach to understand the value of equity, and the enterprise value.

    Please keep writing more articles like this.

    Greetings from Peru

  14. Rutuja says

    beautifully explained!

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