What Does it Mean When the Enterprise Value is More Than Market Cap?

Below, this answer has over 21,500 views on Quora and is by far the most viewed answer I’ve posted on the crowdsourcing site. I hope you enjoy and learn a lot from it too.

Value Investing Journey is dedicated to developing the world’s best value investors. In that vein, I occasionally answer questions related to value investing, finance, learning, mental models, etc., on the crowdsourcing site, Quora. I hope you enjoy the question above and answer below.

Below is an answer I wrote on Quora to the above question. The question and answer are important to how we all learn our craft of value investing so I’ve decided to post it here as well.

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I’ll add a bit more to the other answers.

Market cap is the value of the company’s shares multiplied by its share price on the stock market.

This calculation doesn’t include cash or debt.

Almost every company on the stock market has either cash, debt, or both so market cap isn’t a good estimate of a company’s value. This is where enterprise value comes in.

Enterprise value = Market cap – Cash + Debt. My note here: you also subtract preferred stock and minority interest, but in my realm of dealing with tiny companies, most companies this size don’t have either of these.

Not only does this give you a truer estimate of what the company is actually worth, but it’s a decent estimate of what the value of the company is, if you wanted to own the whole company.

This is how many value investors treat buying a company’s stock as if we were to buy a portion of the whole company. This is why enterprise value is so important.

But you can go a step further still.

If the company has operating leases, unfunded pensions, and net deferred tax asset, the enterprise value still doesn’t tell you what the company is worth. This is where total enterprise value comes in.

TEV = Market cap + all debt equivalents (including the capitalized value of operating leases, unfunded pensions, etc) – cash, cash equivalents, and short-term investments – long-term investments – net deferred tax assets.

Let’s use an example to illustrate why calculating TEV is necessary for companies who have the above three things that EV doesn’t count.

TEV = 1000 (market cap) + 200 (short and long term debt) + 210 (operating leases of 30 in the next year multiplied by 7) + 300 (unfunded pensions) – 100 (cash and cash equivalents) – 50 (ST investments) – 100 (LT investments) – 100 (net deferred tax assets) = 1360. Or 1360 to buy the whole company.

Using only EV, you would have to pay 950 for the whole company, or ~30% less than what the company is actually worth when considering everything.

Let’s say the company has 20 million shares.

This means using TEV you would have to pay $68 per share to buy the whole company.

Using EV you would have to pay $47.50 per share, and considering only market cap, the company is worth $50 per share.

So what does this all mean?

If you consider buying stock as buying a portion of the whole business, the TEV calculation is the most accurate and is a number you must know.

If a company doesn’t have operating leases, unfunded pensions, or net deferred tax assets, you’ll be fine just calculating EV.

Market cap is the most useless number here because it doesn’t consider anything of actual value within the company.

But most people only rely on market cap, because it’s easy.

If a company’s EV or TEV is less than its market cap, it means that the company has more cash than debt, and may be undervalued. The inverse is true as well.

EV and TEV can also be negative. This means that the company has more cash than debt and market cap combined. When this happens, it’s one sign that the company may be undervalued by a huge margin to what it shares are worth.

Again, the inverse is true. If the company’s EV and / or TEV numbers are higher than the market cap, it means the company has more debt and may be overvalued.

But the valuation talk is for another post and requires taking a further step to figure. To view the discussion on valuation, go to my post here, Why The P/E Ratio Is Useless and How To Calculate EV.

Hope this helps.

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