Investing Series: What does enterprise value mean?
This is a part of the Investing Series.
Remember how we chatted last week about what a market capitalization (market cap) was?
An enterprise value is basically the same thing as a concept as in refers to how much a company is worth, or the size of the company, but not just its size on the stock market relative to others around it.
HOW IS ENTERPRISE VALUE DIFFERENT FROM MARKET CAP?
It is considered are more accurate look at how big a company is.
Market cap is just how big it is on the stock market, but it doesn’t tell you how much debt it holds, how much cash it haves, etc.
You can think of it as its resale value, if let’s say they were about to be bought out in a big fire sale, what would it go for?
Obviously it wouldn’t go for the price of its market cap because it has debt for instance, so there’s where enterprise value comes in.
Think of it like buying a used laptop, and here’s a very general analogy to follow:
Let’s say the guy who is selling it, paid about $3500 for it originally (about a month ago) and got all the upgrades, bells and whistles, etc.
Let’s say he also took out a loan (that idiot!) to buy this laptop and still has $500 left to pay for the laptop which you the buyer would have to clear before getting this machine.
If you were to buy it, first of all, you wouldn’t pay retail price for it even though it’s only a month old, so you’d pay maybe $3000 for it.
Then you factor in that you also have to pay that $500 debt, so you make him an offer of $2500 in cash for his month-old, $3500 laptop with a $500 outstanding debt on it.
The enterprise value of that laptop would be $2500.
(Actually in reality, let’s say $2400 because let’s face it.. if he needs the money right away, you could probably squeeze a little more out of him.)
HOW TO CALCULATE ENTERPRISE VALUE
Now we get down to the fun stuff!
ENTERPRISE VALUE =
Market Cap + Debt + Minority Interest + Preferred Shares
– Cash – Cash Equivalents
So remember how we talked about market capitalization (market cap)? You’ll have to use that number here too.
Let’s do an example with The Gap!
Here’s what it looks like in Google Finance:
Using a combination of their Income Statement and Balance Sheet, we can find every single number and then do some basic addition.
MARKET CAP = $19.06B
Their Market Cap is: $19.06 B
(Yeah, you can cheat like I do, and just steal numbers from these financial sites rather than trying to calculate it all on your own, just pick a reputable site like Google or Yahoo).
DEBT = $1,246M
Their debt can be found on their Balance Sheet.
I took the number that says Debt which refers to their Long-Term Debt, but you could certainly include “All Liabilities”, if you want to consider all of that as Debt to be ultra-conservative.
MINORITY INTEREST = $0
Now let’s look for their Minority Interest on their Annual Income Statement which in this case looks to be a big fat 0:
ERR WAIT! WHAT DOES ‘MINORITY INTEREST’ MEAN?
It just means how much of the stock is owned by another company other than the parent company or in this case, Gap Inc.
It’s a non-controlling ownership, meaning they don’t decide and vote on company matters.
So for instance, if the parent corporation The Gap Inc. also had a subsidiary like The Gap Real Estate Inc., and that subsidiary held 15% of the shares, then it would show up on there as Minority Interest, because it isn’t 100% owned by Gap Inc.
PREFERRED SHARES = $0
Looks like on their Balance Sheet, they don’t have any preferred shares issued.
CASH / CASH EQUIVALENTS = $518M
Shooting back up to the top on their Balance Sheet, their cash & equivalents are listed at the top.
(Everyone loves cash)
NOW JUST ADD AND SUBTRACT THE ABOVE NUMBERS:
Don’t forget to equalize the billions to the millions… that is, make your base numbers the same or else you might make a mistake.
ISN’T THERE A SHORTCUT?
Always! But it’s nice to know how it’s all calculated in general, so that you know what goes into the number.
You can just go to Yahoo Finance and find its Enterprise value listed near the top at $19.25B.
WAIT A MINUTE! THE NUMBERS ARE NOT THE SAME!
Yes it’s off by $0.54B, which looks like a tiny amount but is NOT.
That’s partly because I used Google Finance information that says Market Cap = $19.06B, but Yahoo Finance says the market cap is $19.17B.
They also probably calculated it using different debt, and so on and so on.
ER…SO WHAT NOW? WHICH NUMBER IS RIGHT?
They both are.
CONGRATULATIONS MY YOUNG PADWAN!
I’d like to officially welcome you to the finance world, where numbers change pretty much all the time based on what assumptions you make.
As you may recall, market cap is determined by its current stock price multiplied by its number of shares outstanding, so because the stock price fluctuates every second, so will the enterprise value because it uses it in the formula.
Ah. Sweet logic.
Not only that, this is also the justification that investment bankers use on companies to fleece them into hiring them and paying $$$$$$$$ prices to tell them things like:
Well but your market cap TODAY is $19.17B, so let’s use the number TODAY rather than the number yesterday, that was at $19.07B, because let’s face it.. we like bigger numbers, among other things.
See how smart we are?!?!?
We, the infinite wisdom holders with the title of ‘investment banker’ can tell you, lowly company that needs our financial wisdom which numbers to cherry pick to use to determine how much your company is worth so that you can fleece your buyer!
Aren’t you happy you’re paying us $1000 an hour?
Right. That’s kind of how it goes in my mind, and quite possibly, in real life.
- Enterprise value is a more accurate look at what a company is worth
- It uses the more general “market cap” value as part of its formula
- It can change by the second
Thanks for the Investing series, I find these posts extra helpful.
Thanks for this fascinating info, Mochimac!!! Do you know of a good investing resource for beginners?