What’s the Difference Between Enterprise Value and Equity/Market Cap?
Market value of debt: Measures the market value of bonds issued, lines of credit, loans, leases, and other instruments. Debt is included because enterprise value considers capital contributions from all sources. Market value of minority interest: An adjustment to enterprise value that reflects the accounting treatment of subsidiaries. A company that has more than 50% ownership of a subsidiary has to include 100% of the subsidiary’s assets, liabilities, and income in its financial statements. So if Company A owns 80% of Company B, 100% of Company B’s sales, earnings, assets, etc. are included in the line items of Company A’s financial statements. An adjustment is then made to reflect the overstatement that’s called minority interest. The problem occurs because enterprise value is a part of many financial ratios used to measure performance, such as enterprise value/sales. In this case, 100% of the subsidiary’s sales are included in the parent company’s financial statement. Unless minority interest is included in the enterprise value, the ratio is understated. Cash: Gets subtracted from enterprise value with the assumption that it is used to pay down debt.
What They Measure
Market capitalization measures the size of a company and categorizes it relative to others. There are three broad categories of market capitalization:
Large-cap: $10 billion or moreMid-cap: $2 billion to $10 billionSmall-cap: $300 million to $2 billion
Application
Enterprise value is used by investment bankers and analysts in mergers and acquisitions to estimate the market value of the company. It also is used by portfolio managers in their stock selection process. Equity value/market cap is used for strategic investing by portfolio managers. Each market-cap category provides a profile of the stage of the business, position within its sector, stability, business focus, growth potential, price volatility, and risk. Within each category, there are styles. For example, growth companies are expected to increase their sales, revenue, and profit faster than the market. Value companies are considered “bargains’’ because their share prices do not reflect the stocks’ true values. Blue-chip stocks are large-cap companies that usually have track records of delivering earnings, dividends, and weathering economic downturns. Smaller-cap companies may have potential for rapid growth, but they also tend to be more sensitive to economic changes. Their share prices also tend to be more volatile than large-cap companies.
The Bottom Line
Enterprise value and equity, or market cap, are used for different purposes in evaluating companies for investment. Enterprise value is used to determine market value of a company. On the other hand, equity/market cap can be used as a profile of the company. If you are doing your own investment research, enterprise value should be an important consideration in your stock selection. At the same time, for the average investor, market cap is a good way to categorize and manage risk within your portfolio. Whether you’re a “do-it-yourselfer” or you’re working with an investment professional, a solid understanding of stocks’ categories and styles can help you craft a strategic investment plan.
