Equity Value and Enterprise Value

by veristrat

Valuation is an integral part in the field of finance and has significance in different areas such as merger and acquisitions, corporate finance, financial reporting etc. The value of a firm is a reflection of its operating, financing and investing decisions. When a valuation analyst values a company, the terms equity value and enterprise value are first to come in mind, where equity value is the market capitalization of the company i.e. the portion available to its shareholders and enterprise value is a measure of company’s total value that is attributable to all its investors. In other words equity value is the number which public at large sees while enterprise value represents its true value. In terms of formula:

Equity Value = Common Shares Outstanding * Share Price
Enterprise Value = Equity Value + Debt – Cash + Minority Interest + Preferred Stock


equity_value

Equity value tells you at a glance how much a company is worth, whereas enterprise value tells you more accurately how much it would really cost to acquire the company. When you buy a house, there are all sorts of hidden costs like required repairs, unpaid bills, obligations, and more, but you might also benefit from, for example, getting furniture for free with the house. Enterprise value works the same way, it takes into account the obligations that you need to repay, like debt, and also the “free gifts” you get, like cash, and gives you the true cost to acquire a company.

Before investing in a company, investors would like to know the worth of the company. But the question arises which value to look for, Equity or Enterprise? Enterprise value and equity value are the basic foundation for an investor. Many investors get confused in different valuation metrics that represent the total value of a company. A company with more cash than debt will have an enterprise value less than its equity value and a company with more debt than cash will have an enterprise value greater than its equity value. Valuation multiples associated with enterprise value and equity value help valuation analysts for comparable company analysis.

Equity Value vs. Enterprise Value

Area of Comparison Equity Value Enterprise Value (EV)
Meaning • Refers to the value of company’s market capitalization.
• Gives just a glance how much a company  is worth.
• Refers to the value that would really cost to acquire the company.
• Gives more accurate value of a company by taking consideration of its debt obligations.
Preference Preferred in processes like investing in equity and equity valuations Preferred in processes like mergers, acquisitions and leveraged buyouts.
Multiples associated Price/EPS (P/E),Equity Value/Book Value, P/E/Growth (PEG Ratio) EV/EBITDA, EV/EBIT, EV/Sales

 
While conducting a comparable company analysis, selecting a multiple to use for particular industry sometimes get difficult. There is no set of specific guideline for multiple selection however some generic applications are noted below:

Multiple Application
EV/EBITDA One of the most commonly used valuation multiple and is useful for valuing capital intensive businesses with high level of depreciation and amortization.
EV/EBIT Used when depreciation and amortization expenses are small, as in the case of a non-capital-intensive company such as a service firm.
EV/EBITDA One of the most commonly used valuation multiple and is useful for valuing capital intensive businesses with high level of depreciation and amortization.
EV/ Sales Is used where company has no debt.
P/E Used while comparing the price of two stocks in the same sector. Investors should prefer the one with the lowest PE.
Equity Value/ Book Value Useful where tangible assets are major source of value creation.
PEG Ratio Used to determine stock’s value while taking into account the growth in earnings.

 
From a layman’s point of view both the valuation metrics look similar however both holds their individual significance depending upon the nature of business and investors perspective of investing. Therefore an investor should always be cautious of his needs and preferences with respect to the usage of the two above mentioned metrics.


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