Sunday, May 14, 2017

Using Enterprise Value To Compare Companies


Courtesy : Investopedia

The enterprise value - or EV for short - is an indicator of how the market attributes value to a firm as a whole. Enterprise value is a term coined by analysts to discuss the aggregate value of a company as an enterprise rather than just focusing on its current market capitalization. It measures how much you need to fork out to buy an entire public company. When sizing up a company, investors get a clearer picture of real value with EV than with market capitalization.

Why doesn't market capitalization properly represent a firm's value? It leaves a lot of important factors out, such as a company's debt on the one hand and its cash reserves on the other. Enterprise value is basically a modification of market cap, as it incorporates debt and cash for determining a company's valuation.

The Calculation
Simply put, EV is the sum of a company's market cap and its net debt. To compute the EV, first calculate the company's market cap, add total debt (including long- and short-term debt reported in the balance sheet) and subtract cash and investments (also reported in the balance sheet).

Market capitalization is the share price multiplied by the number of outstanding shares. So, if a company has 10 shares and each currently sells for $25, the market capitalization is $250. This number tells you what you would have to pay to buy every share of the company. Therefore, rather than telling you the company's value, market cap simply represents the company's price tag.

The Role of Debt and Cash
Why are debt and cash considered when valuing a firm? If the firm is sold to a new owner, the buyer has to pay the equity value (in acquisitions, price is typically set higher than the market price) and must also repay the firm's debts. Of course, the buyer gets to keep the cash available with the firm, which is why cash needs to be deducted from the firm's price as represented by market cap.

Think of two companies that have equal market caps. One has no debt on its balance sheet while the other one is debt heavy. The debt-laden company will be making interest payments on the debt over the years. (Preferred stock and convertibles that pay interest should also be considered debt for the purposes of calculating value.) So, even though the two companies have equal market caps, the company with debt is worth more.

By the same token, imagine two companies with equal market caps of $250 and no debt. One has negligible cash and cash equivalents on hand, and the other has $250 in cash. If you bought the first company for $250, you will have a company worth, presumably, $250. But if you bought the second company for $500, it would have cost you just $250, since you instantly get $250 in cash.

If a company with a market cap of $250 carries $150 as long-term debt, an acquirer would ultimately pay a lot more than $250 if he or she were to buy the company's entire stock. The buyer has to assume $150 in debt, which brings the total acquisition price to $400. Long-term debt serves effectively to increase the value of a company, making any assessments that take only the stock into account preliminary at best.

Cash and short-term investments, by contrast, have the opposite effect. They decrease the effective price an acquirer has to pay. Let's say a company with a market cap of $25 has $5 cash in the bank. Although an acquirer would still need to fork out $25 to get the equity, it would immediately recoup $5 from the cash reserve, making the effective price only $20.

Ratio Matters
Frankly, knowing a company's EV alone is not all that useful. You can learn more about a company by comparing EV to a measure of the company's cash flow or EBIT. Comparative ratios demonstrate nicely how EV works better than market cap for assessing companies with differing debt or cash levels or, in other words, differing capital structures.

It is important to use EBIT - earnings before interest and tax - in the comparative ratio because EV assumes that, upon the acquisition of a company, its acquirer immediately pays debt and consumes cash, not accounting for interest costs or interest income. Even better is free cash flow, which helps avoid other accounting distortions.


The Bottom Line

The value of EV lies in its ability to compare companies with different capital structures. By using enterprise value instead of market capitalization to look at the value of a company, investors get a more accurate sense of whether or not a company is truly undervalued.

65 comments :

  1. Sir , do you track BP Capital ?

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  2. Sir really valuable information, thanks for sharing this kind of basics for stocks analysis. Thank and God bless you.

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  3. Dear Sir, Please provide your valuable views on Time Technoplast, Ester Industries, Yash papers, Oriental Trimex.

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  4. Hi VP, would appreciate having your views on Shree Rama Multi as an investment theme? Thanks

    ReplyDelete
    Replies
    1. Need to wait and see how management is taking efforts to revive it.

      Delete
  5. sir, please give your views on Artson result and ducon . .

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  6. Respected VP Sir,

    Kindly share your view on electrotherm ltd and glenmark.

    Regards,
    Dheeraj

    ReplyDelete
    Replies
    1. Electrotherm - Wait and see how they are managing debt

      Glenmark - for passive investors in correction

      Delete
  7. very informative VP sar!!

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  8. Dear Sir, You views about eClerx and Bajaj Holding and Investments stocks?

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  9. Hi,
    Can you please provide your views on SKY Industries

    ReplyDelete
    Replies
    1. Not tracking above mentioned stocks

      Delete
  10. Sir, greetings! Is there any scope to continue hold Skm egg products, exports realisation may be weak with strong rupee? Unless forward cover

    ReplyDelete
    Replies
    1. Product price in international market is also soft.

      Delete
  11. Sir what is view regarding Future Consumer?
    Thanks a lot

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  12. VP Sir, any stock from housing finance sector you tracking?? please share if any so that we can study that cos too :) Thank you Sir

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    Replies
    1. Already suggested Canfin and GIC at lower level.

      Delete
  13. Dear sir
    What's your views on
    1. Kirti industries
    2. Shrenuj & CO.
    3. South Indian bank.
    Thanks

    ReplyDelete
    Replies
    1. Sorry , not tracking any of these.

      Delete
  14. Sir, your view on SKM eggs and MIC electronics now. Is it still good to hold for a long term or not?

    ReplyDelete
    Replies
    1. SKM is a stock already suggested to exit @ Rs.120

      MIC suggested at Rs.4 , as part of debt reduction equity expanded heavily in MIC this may create pressure on up move of price in market , latest result was also below expectation.

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    2. VP sir, any entry points for SKM egg considering that its already discountinglot of negatives

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  15. First of all thanks a lot for suggesting gems NR Agarwal and Stylam and Amulya leasing . They have doubled multiple times on suggested price.
    Do you still think steam left to hold further OR switch to other ones?

    ReplyDelete
    Replies
    1. Out of the above Paper industry is a cyclical one , take investment decision after considering this point.

      Delete
  16. VP, want to know Ur current view on Ur old picks :
    GIC Housing
    Muthoot capital
    LT Foods
    Also tell, is more accumulation can be done in Goodyear at this rate in core portfolio ?
    Thanks

    ReplyDelete
    Replies
    1. All these stocks multiplied many times from suggested rate , neutral at CMP.

      Delete
  17. Dear VP ji
    Please share your present thoughts on time technoplast .
    Which will be helpful to us.

    Thank you.

    ReplyDelete
  18. Hello sir, are you positive on any financial services firm in long term? Also any stock you are are tracking in HFC sector? Thanks in advance for your precious views.

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    Replies
    1. Suggested many stocks like Capital First, Cholamandalam, Canfin Homes..etc in the past at lower level from these sectors. On value based investment entry price is very important .

      Delete
  19. Dear sir, what is the topline & bottomline of apollo pipes (amulya leasing) please share,how much more time can we expect for merger, any change in previous views...Thanks & Regards :)

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    Replies
    1. I expect merger will happen in two months

      Delete
  20. Enter your comment...sir, is capital first still a hold

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    Replies
    1. Prefer to make it free of cost and hold the rest

      Delete
  21. Sir, do you look further good happenings in Caplin ? Holding since quite long..

    ReplyDelete
    Replies
    1. Adjusted to stock split ,Caplin Point already given 34 times return in just three years from recommended level, what we need more than that ? :)

      Delete
  22. Vpji what is ur outlook in hudco?

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    Replies
    1. May deliver for long term passive investors.

      Delete
  23. Hi VP, Please post ur views on investing in
    1.virinchi tech
    2.allcargo
    3.National fertilisers limited
    4.future retail
    5.surana solar

    ReplyDelete
    Replies
    1. Not tracking any of the above mentioned companies.

      Delete
  24. Respected VP sir,
    Any suggestions of stocks for agri theme as the same is hotting up.

    ReplyDelete
    Replies
    1. Too hot , that's the problem for those following value based investment strategy.

      Delete
  25. Sir,

    Please provide your view on latest ABFRL results.

    ReplyDelete
  26. Hello sir...suzlon has posted strong numbers.Is it a long term hold...ur views on it pls?

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  27. VP Sir,

    Sunit Hitech was recommended here in 2014 after which prices increased steadily until last year when the 1:10 split took place and promoter holding was diluted. Is entry at CMP advisable for long term?

    ReplyDelete
  28. Sir,
    Please provide your views on Vivid Global Industries

    Thankyou!

    ReplyDelete
  29. VP sire, what's your view on Neha International and Intense technologies, are these good stock to enter.

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  30. Please provide your view on Alps Industries!

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  31. Sir, I am still holding Mold-Tek packaging which you recommended few years back. Thank you so much. Do you have any suggestion on this stock? Should I still hold this stock?

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  32. Respected Sir,

    I thing i would like to say is you are doing a good job by helping others and let them know your views. Awesome and hats off for that.

    Previously you have wrote an article about V2 reatil. As you mentioned it picking up. What are your view about it now. ? I am willing to invest on it for the current market price. Please guide me!

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  33. Sir have you looked at Hitech Pipes listed only on NSE. They are expanding in South India. Does it look better than Amulya.

    ReplyDelete
  34. Ur view on Shree Rama Multi result.
    Also on Ramky Infra.

    ReplyDelete
  35. Sir, what is your view on latest Moschip semiconductor results and moreover promoters also increased there shares from 18% to 64%.

    ReplyDelete
  36. sir pls provide your views about pincon sipirit results.

    ReplyDelete
  37. What is your views on nath biogeans Sir

    ReplyDelete
  38. sir pls provide your views about celebrity fashions result.

    ReplyDelete

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