What is enterprise value?
Why is it used by so many successful investors?
And what are all the parts of the equation that make up this important metric?
All the answers…
coming up!
It makes me so happy to know that you’re watching this video.
I’m excited for you to take this small step on your path to building your rapidly-growing,
highly-diversified net worth, one video at a time.
The most straightforward way to value a company is by multiplying its share price by the total
number of shares outstanding.
This gives you (what is called) a company’s Market Capitalization or Market Cap for short.
Essentially, this tells you how much it would cost to buy every share of a company, to own
100% of that company.
This simple metric is what’s used when stocks are divided up by their size.
But for a successful investor - trying to fully understand the value of a company, not
just what all the shares are worth, but the actual complete picture of a company’s value
as an investment - this metric is not enough.
(And I hope that statement makes more sense to you in just a second.)
But it’s because of this, that (more often than not) those successful investors use Enterprise
Value, or EV.
Enterprise Value more accurately represents the net impact - the bottom-line effect as
an investment - on the portfolio of a potential acquirer who might take full ownership of
a company.
So… if you’re buying shares in a company (you know, actually becoming part owner in
that company…), knowing what you would be out-of-pocket if you could just take over
and purchase the whole entire thing…
(not a bad perspective - putting yourself in the shoes of a potential acquirer) that’s
valuable information, right?
It’s at least a more realistic representation (than Market Cap) of the value the market
is actually currently assigning to the company in question.
Five variables go into this calculation and when you think about each one, it’s obvious
why EV is more comprehensive and useful than the traditional Market Cap.
You start (where we’ve already started) with the company’s Market Cap - what you
would have to pay to buy 100% of the shares outstanding, becoming 100% owner the company.
You just bought the entire company, so that will increase your assets (right?)… but
that’s not the end of it.
That’s not the only effect this acquisition will have on your financial situation.
If you’re now 100% owner of the company, you also now own 100% of its debts… both
long- and short-term.
So you’ll need to factor that in.
You can do that by adding it all to the Market Cap.
Pretend as though, upon purchase, you’re also going to pay off every single creditor.
(You don’t have to do that, but you will owe them all money at some point… so it
needs to be factored in.)
On the other hand, what if the company comes with some cash or cash equivalents.
Well, that helps.
That’ll work in your favor so you can subtract that amount from your total - the amount you’re
essentially paying for this company.
Sometimes, this can be significant - Apple, for example, as of this recording, has well
over $250B in cash reserves!
Obviously, when you’re thinking about your Apple takeover bid (or just your own valuation
of the company), this should factor in…
That’s most of your Enterprise Value calculation: Market Cap + Total Debt - Cash.
Now, I said there were five factors.
There are.
The other two are usually pretty small if they even exist at all for your company in
question.
At times, there are Minority Interests and/or Preferred Shareholders out there.
These are other people or entities with claims to the company.
Of course, then, they should be added in as well.
They too are not considered in your basic Market Cap calculation but obviously represent
some value.
So there you have it: a simple way to gain a clearer picture of the actual value of a
company.
Market Cap + Minority Interest + Preferred Shares + Total Debt - Cash = Enterprise Value.
And Enterprise Value comes up a lot in the ratios used to compare and assess the fair
value of different companies.
We’ll be exploring some of those ratios, as well as other important metrics as we continue
to build out your rapidly-growing, highly-diversified net worth.
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