Saturday, November 25, 2017

Using Enterprise Value To Compare Companies ....

Courtesy : Forbes 


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.

49 comments :

  1. Superb learning Sir! Thanks
    Sir any specific industry in which EV is more important to calculate valuations or its equally effective for all types of industries to know whether the price is undervalued or overvalued? What should be the ideal range if EV for a company to label it as undervalued?

    ReplyDelete
    Replies
    1. It is only general guidelines , investors should take a case to case based call along with this while investing in stocks.

      Delete
  2. Sir pls advise on manappuram finance and zen tech can enter present rate and also advise ramky for entering as on now.

    ReplyDelete
  3. Dear VP Sir, Can you please throw some light on Jai Corp.

    ReplyDelete
  4. Dear value pick sir
    Plz share view in anantraj,onmobile global n panecea bio for longterm..

    ReplyDelete
    Replies
    1. Prefer to hold Panaces if you have an above average risk appetite , as of now not tracking others

      Delete
  5. sir ur view on gati n uniply for long term

    ReplyDelete
  6. VP Sir,

    Any view on Raunaq EPC with expected revival in infra activities?

    ReplyDelete
  7. sir, any latest update on WONDERLA sir? good to hold?

    ReplyDelete
    Replies
    1. Expecting range bound movement in medium term , may turn as a compounder in long term.

      Delete
  8. sir pl advise your view on media industry. wt about tv 18

    ReplyDelete
  9. Are you tracking Apex Frozen Food. It has appreciated almost 3 times since its debut post IPO. IS it still good to buy on dips?

    Any other stock from this sector you are tracking?

    Thanks

    Vinayak

    ReplyDelete
  10. vp sir,
    r u still tracking fiberweb.Kindly let us know something about its promoter & comapny business.
    I am invested after your first recommandation & sitting on good profit & not sold any shares till date hence would like to update from your goodself as what to do.
    Awating your reply.

    ReplyDelete
    Replies
    1. This stock suggested when its price was around Rs.75 . At that time (though there was some negatives) its risk reward ratio was favorable for an average risk taker. But off late it seems some unnecessary efforts to attract investor attention.Personally I would prefer to avoid any companies doing the same and as a matter of policy discontinue tracking it . So take a call based on your study and risk appetite.

      It may go anywhere but I would prefer to stick on the principles I am following in investing irrespective of opportunity losses ( if any ) :)

      Delete
  11. Any view on your previous hold on suzlon?

    ReplyDelete
  12. Sir, pl share ur views on C&C construction. Will there fund raising initiative is a positive move. Thanks

    ReplyDelete
  13. Dear sir,
    I want your views about godrej agrovert, tube investment(post demerger), and akzo noble at current cmp, kindly advice.

    ReplyDelete
    Replies
    1. All of these are good companies , but as an investment enter at a comfortable valuation.

      Delete
  14. Good Morning VP

    Your views on Thyrocare Technologies Limited and it's near term target?
    Regards JAYPEE

    ReplyDelete
    Replies
    1. Basically I am investing in a stock with a belief that the price of stock will increase with an improvement in the business growth of companies , because of this reason I am not expecting anything in short term while investing in stocks and trying to figure out targets. My targets keep changing depends on the business growth of company over a long period.

      Delete
  15. Your views on fiberweb issuing bonus shares sir and on CMP to enter ?

    ReplyDelete
  16. Dear VP Sir, Do you have any opinion about Stampede Capital. It has reached its 52 week low in recent times.Is it the right stock & price to enter

    ReplyDelete
    Replies
    1. Go through the content of following link and decide yourself

      http://www.bseindia.com/stock-share-price/stockreach_insidertrade_new.aspx?scripcode=531723&expandable=2

      Delete
  17. Sir thanks for all the advice you have given. I hold apar industry, capital first as per your recommendation. Now I am thinking of buying Aditya Birla capital what is your take. Can you please advise me

    ReplyDelete
  18. Dear sir
    What's your opinions about tata coffee considering future aspects.

    Thanks a ton

    ReplyDelete
  19. Dear sir,
    What is your current view after seeing the September quarter results of IL&FS Engg.
    Thanks in advance.
    Regards,
    Ashish

    ReplyDelete
    Replies
    1. Profit only because of other income.

      Delete
  20. Good Morning Sir,

    Pls advice on Gammon Infra projects Ltd and Gammon India Ltd.

    Thanx & Regards
    Mahesh

    ReplyDelete
  21. Sir, excellent results posted by Share India securities.. looks like a multi bagger in making... thanks for showing us this gem

    ReplyDelete
    Replies
    1. Profitability of companies in this industry closely linked with the market sentiment , so adjust timing of exit .

      Delete
  22. Sir , do u think Anjani Portland cement is long way to go?

    ReplyDelete
    Replies
    1. Good one from the industry , rest depends on sector tailwinds.

      Delete
  23. Sir, Pls guide on Panacea Biotec.

    ReplyDelete
  24. Hi sir, Please let me know your thoughts on buying Escorts at current level. Thanks.

    ReplyDelete
  25. Hi, what is your view on steel exchange India.

    ReplyDelete
  26. Dear vpji,
    Recently some prominent personalities joined board of sankhya info. I know that stock has very bad history but joining of such names in board shows confidence in company's outlook. Your views please.

    ReplyDelete
  27. Sir, do you track RM Drip?

    ReplyDelete

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