Enterprise value vs. Market cap: How to measure a stock?

Learning how to measure the value of a stock is important for investors. Enterprise value and market cap are both important metrics in this regard.

Oct 14, 2020 10:10 IST India Infoline News Service

For investors looking to invest in a stock for the long term, it’s imperative that they know what the value of a stock is. There are many strategies that can be used to compute this number. Among the most common is the market cap. By figuring out the market cap, it’s easy for investors to get a fair idea about the value of a stock.

But aside from market cap, there’s another metric that can help investors get to know a stock’s value better. This is the enterprise value. Although people often mistake one to be the same as the other, market cap and enterprise value are two different metrics entirely. What are they, though? And how do you use them to measure the value of a stock?

That’s just what we’re about to find out.

What is market capitalization?

Known more commonly as market cap, this is basically the market value of a company’s stocks. In other words, it’s the total market value of all the outstanding shares in a company. The market cap of a company is calculated using this formula.
Market cap = total number of shares outstanding x current market price per share

For example, say a company has 20 lakh outstanding shares. And it’s market price on the NSE is currently Rs. 300. In this case, the company’s market cap would be Rs. 6,000 lakhs or Rs60cr.

The market cap of a company is not a constant value. Since it depends on the market price of the shares, it keeps fluctuating as the price of the shares change. Based on this metric, companies are classified as large cap, mid cap and small cap. Let’s find out what they mean.
  • Large cap: Generally, these companies, which have a large market cap, are well-established entities. They enjoy steady streams of income and their prices may be less volatile than other companies. Large cap companies may have market caps over Rs20,000cr.
  • Mid cap: Mid cap companies fall in-between large cap and small cap companies. They’ve generally grown past the initial stage of a company’s life cycle, but they’re still not as established as large cap companies. Companies with market caps between Rs5,000cr and Rs20,000cr generally fall in this category.
  • Small cap: Small cap companies have relatively smaller market cap. Often, they may not have achieved significant levels of growth. In India, companies with market caps below Rs5,000cr are generally classified as small cap.
Measuring a stock’s value with the market cap

The market cap gives you an overall idea about the value of a company. It’s frequently used in fundamental analysis, which helps you arrive at the value of a stock. By itself, the market cap may not give you the exact value of a stock. But it can help you understand how a company compares with its peers.

What is enterprise value?

Enterprise value, abbreviated to EV, is a more comprehensive metric that takes into account many factors like market cap, debt, minority interest, total cash and cash equivalents and preference shares to determine the total value of a company.

Here’s how the formula goes.

Enterprise value = market cap + market value of preference shares + total debt  + minority interest – total cash and cash equivalents.

From this formula, it becomes evident that if a company has less cash and higher debt, its EV may be higher than its market cap. Conversely, if the cash is higher and the debt is low, the company’s EV may be less than the market cap.

Measuring a stock’s value with the enterprise value

The EV of a company gives a more detailed picture than the market cap. Enterprise value accounts for debt and other elements, unlike market cap. So, investors looking to invest in a company for the long term will also benefit from factoring in the EV. Additionally, there are many other ratios too that can be useful in this regard. Some of them include:
  • EV/EBITDA (Earnings before interest, tax, depreciation, and amortization)
  • EV/EBIT (Earnings before interest and tax)
  • EV/CFO (Cash from the operation)
  • EV/FCF (Free Cash Flow)
  • EV/Sales or Revenue
  • EV/ Assets
Conclusion
Either way, before you invest, it is always good to quickly do a bit of research into the market cap and the enterprise value of a company. Fundamental analysis to arrive at the value of a stock can also help you make informed investment decisions.

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