How to use a company’s enterprise value to weigh up what it’s really worth

Julie Brownlee, Fsp Invest, 03 Feb. 2015

Tags: enterprise value, what is enterprise value, using enterprise value, calculating a company’s worth, investing in shares,

When looking at a company’s share price alone it can be hard to work out whether a company is cheap or not.

This means that you need to look at others ways of working out what a company is really worth. In other words, you need to look beyond the equity in a company.

So what’s the best way to do this? You can use a company’s enterprise value.

Read on to find out more…

The problem with using a company’s share price alone

When you buy shares in a company, you’re paying for a portion of the company’s equity value. This is the company’s market value of its assets minus the company’s liabilities.

By concentrating solely on equity, you can end up thinking a share is cheap when it actually isn’t.

So you need to look at a different way to weigh up a company’s worth and its shares.

Using a company’s enterprise value

A company’s enterprise value is the value of a company as a whole. It’s not just the value of the equity.

If someone decided to buy a company, this is the value they’d have to pay as they’d also have to take on any financial liabilities the company had.

So how can you calculate a company’s enterprise value?

You add together the following:

  • A company’s market capitalisation (this is the number of shares in circulation multiplied by the current share price);
  • A company’s net debt (this is any debt minus cash);
  • A company’s minority interests; and
  • A company’s preferred shareholdings.

If a company holds a lot of cash, you may find that it has a negative EV.

Why use a company’s enterprise value?

Many professional investors like using a company’s enterprise value because the way a company is financed doesn’t affect it. So it doesn’t matter the proportion of equity to debt.

This means that they can use the enterprise value to easily compare the business with other companies that have different financial structures.

So there you have it. How to use a company’s enterprise value to weigh up what it’s really worth.

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