Enterprise Value and Equity Value

Enterprise Value (EV): value of a company's core business operations to all investors

Equity Value (EqV): value of everything a company has to its equity investors (common shareholders)


Equity Value & Enterprise Value Conversion:

EV = EqV - Cash + Debt + Non-Controlling Interests + Preferred Stock
EqV = EV + Cash - Debt - Non-Controlling Interests - Preferred Stock

  • Why do we subtract cash to get to EV from EqV:
    • EV, in broad terms, is the present value of a company's future cash flows. The excess cash (not all cash is excess cash) on the books is a non operating asset (non core business operation). It does not aid the generation of future cash flows and therefore does not contribute to value. That's why it is subtracted
    • Also, the equity value of a company already includes the cash on the company's balance sheet. So we need to subtract it or else we'd be double-counting
    • From an intuitive standpoint: when we acquire a company, we'd get the excess cash as part of the deal, lowering the purchase price
    • In the case of a company with a large cash balance (e.g. a bank), we could have negative EV
  • Noncontrolling interests: the amount of a company that you don't own. Used when a company owns more than 50% but less than 100% of another company. Appears on the balance sheet under shareholder's equity. We add noncontrolling interest because it represents another investor group that the enterprise value encompasses

Enterprise Value Calculation Example
  • Let's think about this more intuitively:
  • Say we want to buy Company A with a market cap (equity value) of $10, cash of $5, and debt of $2. 
    • First, we obviously pay off the market cap of $10. Let's call this our purchase price for now
    • Now, we want to pay off Company A's $2 debt. But since Company A already has its own cash of $5, we use that to pay off the debt instead of our own money. Now we have a remaining $3 in cash
    • We will pay ourselves a dividend using that remaining $3 in cash. Now that we received $3 in cash, we're gonna subtract that from our purchase price
    • $10 - $3 = $7. This means that our effective purchase price is $7
    • In other words, the enterprise value for Company A is $7

Valuation Multiples:
  1. EV / EBIT
    • Enterprise value / EBIT
    • Indicates how many times the company's value is worth compared to its earnings
    • E.g. if a company's EV/EBIT is 5, it means the company is worth 5 times the money it makes
  2. EV / EBITDA
    • By excluding non-cash expenses like D&A, interest, and tax rate, it provides a measure of the company's cash flow from operations
    • Indicates how many times the company's value is worth compared to its earnings
  3. P / E
    • Price-to-earnings ratio
    • How much people are willing to pay vs. how much the company makes
    • E.g. if PE ratio is 10, it means people are willing to pay 10 times the money the company makes, so higher PE ratio = people think it's more valuable
There is no best profit measurement. They all tell slightly different variations.
  • EV/EBITDA is better when you want to completely exclude the company's Capex, D&A, and interest
  • EV/EBIT is better when you want to factor in D&A; this is common in manufacturing or industrials
  • P/E is better when you want to factor in interest and non-core business operations; more relevant for commercial banks or insurance firms when you want to factor in interest income and expense

EBIT vs. EBITDA vs. Net Income
  • EBIT = core business profitability before the impact of interest and taxes
    • Reflects operating expenses and after-effects of Capex, but not Capex directly
    • EBIT, Operating income, Operating margin, and Operating profit all mean the same thing
  • EBITDA = a proxy for core business cash flow from operations before the impact of interest and taxes
    • Same as EBIT but doesn't include after-effects from Capex
  • Net Income = profit after taxes, the impact of interest and taxes
    • Reflects everything: operating expenses, the after-effects of Capex, interest, taxes, and non-core business activities












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