Enterprise Value vs. Market Capitalization: An Overview
Enterprise value and market capitalization are both measures of a company’s market value. The two calculations are not identical, and the terms are certainly not interchangeable. Each offers a sense of a company’s overall value and, more importantly, a number that can be used to compare its value to that of its competitors in the same industry. Both numbers are frequently used to determine a fair price to pay for a company’s stock shares.
Market Capitalization
Market capitalizationoften referred to as market cap, is a simple and direct way to calculate a company’s size and value, and, consequently, its potential growth rate and risk outlook.
Key Takeaways
- Market capitalization is the sum total of all the outstanding shares of a company.
- Enterprise value takes into account the debt that the company has taken on.
- Enterprise value, therefore, can identify strengths or weaknesses that market cap cannot.
Market cap is the total value of all outstanding shares of the company’s stock. It is calculated by multiplying the stock’s current share price and the number of shares outstanding. The figure is one of the key statistics that appears with every stock listed in a financial news site or broker’s site.
For example, if XYZ stock is trading at $14 per share and has 2 million shares outstanding, its market capitalization is $28 million.
Large-, Mid-, and Small-Cap
Market capitalization can also give you an idea of the growth and risk to expect from a particular stock. Companies are classified according to market capitalization. The broad categories are large-, mid-, and small-cap.
Generally, large-cap companies are well-established successful companies with steady streams of revenue. Their growth over time may be slow but steady. Their price swings are less volatile than those of smaller companies.
The most appealing small-cap stocks are those that are experiencing accelerated growth, but that growth probably will be at the cost of higher risk and price volatility.
Market capitalization provides an idea of the size of the business and makes it easy to identify peers within a sector.
Market capitalization demonstrates that share price alone tells you little about a company’s overall value. Just because a stock has a high share price does not necessarily mean the company is worth more.
A great example of this is Ford Motor Company (F), with a seemingly low share price of $4.24 as of April 3, 2020. However, Ford is a huge automaker. If you look at its market capitalization, which was about $17.3 billion, you can see that the company is worth quite a lot.
If a company were to be purchased, market capitalization would reflect the cost to acquire the outstanding equity.
Enterprise Value
Market capitalization omits some important facts in the overall valuation of a company. Most importantly, it does not take into consideration the company’s debt.
Enterprise value is used to spot companies that have been undervalued by the markets.
Enterprise value is a more accurate measure of a company’s real worth because it takes into consideration its debt obligations.
To calculate enterprise value, add the company’s market capitalization to its outstanding preferred stock and all debt obligations, then subtract all of its cash and cash equivalents.
Value-Spotting
Enterprise value is commonly used by value investors as a way to spot companies that have been undervalued by the markets. A company with solid earnings and possibly even a decent dividend looks good on the surface. The company might also have a large market capitalization. However, if you look further and calculate the company’s enterprise value, you may find serious debt obligations that could pose a problem.
If you compare the enterprise value of an equally well-earning company and find it has a higher enterprise value, purchasing the latter stock would be a better overall value.
