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There are several ways to judge a company on whether they are worth investing in. The most common is equity market capitalization, but this has some downfalls. This is where enterprise value comes into play.
But what is enterprise value and how does this judge a company?
Here is everything you need to know about enterprise value.
What Is Enterprise Value?
Enterprise value is used to measure the total value of a company. This is considered a more detailed version of valuation. It takes into account the debt portion of a company, rather than just profits and revenues.
It also takes into account the cash that a company has on hand to expand or withstand hardship. it is one of the key ways to understand if a company is performing well or not, but is not considered the gold standard.
How Do You Calculate Enterprise Value?
The standard enterprise value formula is as follows, Enterprise Value (EV) = Market Capitalization (MC) + Total Debt – Cash (C) and cash equivalents.
MC is calculated by taking the current stock price and multiplying it by the number of outstanding stock shares. Total Debt is equal to the total amount of debt that the company has, which consists of both short-term and long-term debt.
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What Makes Enterprise Value Different From Market Capitalization?
Market capitalization is considered the gold standard of valuing a company. It only takes the current stock price and what the stock market thinks the company is worth. This differs on any given day, determined by how many people are buying or selling the stock.
Enterprise value disregards what the stock market thinks and goes into detail about how the company is managing its money as well. This means taking into account not just what the stock market price is that day, but also the cash and debt that the company is carrying.
Negatives of Only Using Enterprise Value
The biggest negative about enterprise value is that not all debt is bad debt. For instance, a company could be utilizing its debt to expand the business and grow the company as a whole. If they are on track to pay off said debt, then technically they are doing good.
It fails to account for positive debt and can lead to a misjudgment of valuation. This can be a problem in certain sectors that are experiencing high growth and are occurring in debt to expand to meet demand.
What Is Enterprise Value? A Clear Component For Investing Decisions
So what is enterprise value? Enterprise value is a great way to understand how a company is doing and should be considered when deciding to invest in it. Just be sure to check what their debt is for and how they are utilizing their cash.
If you want to learn more about the business world and the ins and outs that consist of it, be sure to check out the rest of our blog. If you know someone that could use some help with valuing companies, be sure to share this article with them.