While Market Cap
(share price multiplied by the number of outstanding
shares) represents the company's Price Tag, Enterprise Value
(Acquisition Worth) is calculated by adding total debt (including long- and
short-term debt reported in the balance sheet)
and subtracting cash and investments (also reported in the balance sheet) to
Market Cap.
Two companies
with equal market caps of $250M and no debt; one has negligible cash and cash
equivalents on hand, and the other has $100M in cash. If you bought
the first company for $250M, you will have a company worth, presumably, $250M.
But if you bought the second company for $250M, it would have cost you just
$150M, since you instantly get $100M in cash.
Consider the price of two competitor’s stocks: Air Morton and Cramer Airlines. At $45 per share, Morton had a market cap of $13.5 billion and P/E (market cap/earnings) ratio of 10. But its balance sheet was burdened with nearly $30 billion in net debt. So Morton's EV was $43.5 billion, or about 14 its $3.4 billion in EBIT.
By contrast, Air Cramer enjoyed a share price of $23 per share and a market cap of $6.1 billion and P/E ratio of 20, twice that of Air Morton. But because Cramer owed a lot less - its net debt stood at $3.5 billion, its EV was $9.6 billion and its EV/EBIT ratio was only 10, compared to Morton's EV/EBIT of 14.
By market cap (P/E) alone, Air Morton looked like it was half the price of Cramer Airlines. But on the basis of EV, which takes into account important things like debt and cash levels, Cramer Airlines was priced much less per share. As the market gradually discovered, Cramer represented a better buy, offering more value for its price.
Consider the price of two competitor’s stocks: Air Morton and Cramer Airlines. At $45 per share, Morton had a market cap of $13.5 billion and P/E (market cap/earnings) ratio of 10. But its balance sheet was burdened with nearly $30 billion in net debt. So Morton's EV was $43.5 billion, or about 14 its $3.4 billion in EBIT.
By contrast, Air Cramer enjoyed a share price of $23 per share and a market cap of $6.1 billion and P/E ratio of 20, twice that of Air Morton. But because Cramer owed a lot less - its net debt stood at $3.5 billion, its EV was $9.6 billion and its EV/EBIT ratio was only 10, compared to Morton's EV/EBIT of 14.
By market cap (P/E) alone, Air Morton looked like it was half the price of Cramer Airlines. But on the basis of EV, which takes into account important things like debt and cash levels, Cramer Airlines was priced much less per share. As the market gradually discovered, Cramer represented a better buy, offering more value for its price.
Consider using a Price/Earnings (P/E) value check …
ENTERPRISE VALUE/MARKET CAP x P/E (Market
Cap/earnings)
