Price of the shares versus price of the company
A company’s market capitalization, share price times shares outstanding, only tells you what its equity is worth. Two companies with the same market cap can be very different: one may owe nothing and hold a pile of cash, the other may carry heavy debt. Enterprise value (EV) measures the value of the business itself, whoever finances it.
The formula
EV = market capitalization + total debt + preferred stock + minority interest − cash and equivalents
- Debt is added because a buyer of the whole company would have to repay or take over the loans.
- Preferred stock and minority interest are other claims on the company’s operations.
- Cash is subtracted because the buyer gets it with the company.
Net debt is debt minus cash. When cash exceeds debt, net debt is negative and EV is below the market cap.
Worked example
A company’s shares trade at $50, with 20 million shares outstanding. It has $300 million of debt and $100 million of cash. Over the last 12 months it earned $150 million of EBITDA and $100 million of EBIT on $800 million of revenue.
- Market capitalization: 50 × 20 million = $1.0 billion.
- Enterprise value: 1,000 + 300 − 100 = $1.2 billion.
- EV/EBITDA: 1,200 ÷ 150 = 8.0×.
- EV/EBIT: 1,200 ÷ 100 = 12.0×.
- EV/sales: 1,200 ÷ 800 = 1.50×.
- Net debt: $200 million, or 1.33× EBITDA.
Using the multiples
- EV/EBITDA is the most common valuation multiple in mergers and acquisitions. It ignores depreciation, which suits comparisons between companies with different asset ages, but it also hides heavy capital spending.
- EV/EBIT takes depreciation into account, which is better for capital-intensive businesses.
- EV/sales is used for young companies that are not yet profitable.
- Net debt to EBITDA measures leverage. Lenders often get nervous above 3 to 4×, though acceptable levels vary by industry.
A low multiple can mean a bargain or a business in decline, and a high one strong growth or excessive optimism. Compare companies in the same industry and at the same point in the cycle.
Practical points
Use the latest balance sheet for debt and cash, and trailing or forecast figures consistently. Include lease liabilities in debt only if the EBITDA you use excludes lease costs. Cash that is trapped abroad or needed for daily operations arguably should not be subtracted in full. EBITDA is not a measure defined by accounting standards, so check how each company calculates it.
This calculator gives estimates for education and planning. It is not investment, tax or legal advice; for decisions about your own situation, talk to a qualified financial professional.