What is a 'Total Enterprise Value - TEV'
Some financial analysts use a simple market capitalization analysis to derive the value of a company, but businesses often have different financial structures, making TEV a better value measure when comparing companies.
BREAKING DOWN 'Total Enterprise Value - TEV'
TEV is used to derive the overall economic value of a company. It is used in finance to either compare two companies with different levels of debt and equity or to analyze a potential takeover target. This is because debt and cash have huge impacts on a company's financials. Often, two companies that seem to have similar market capitalizations have very different enterprise values, due to these effects.
For example, if a company was trying to compare its value to the value of a competitor, it would have to look beyond market capitalizations. Let's say that the competitor has a market capitalization of $100 million but has $50 million in debt. The company conducting the comparison might also have a market cap of $100 million but might instead have no debt and $10 million cash on hand. Based on TEV, the competitor's value would actually be higher, due to the effects of the debt.
This TEV measure also dictates potential takeover targets and the amount that should be paid for the acquisition. Using the example above, let's say that instead of a comparison to a competitor, the company was looking to acquire a competitor. Market capitalization rates would say that the takeover target is worth $100 million, the price tag for acquiring the company. Using the TEV, however, shows that the cost of acquisition is really $130 million, due to the debt. This is a more accurate price for the company.
Using the TEV to Normalize Values
The TEV, in addition to a comparison and potential takeover tool, also allows a company or financial analyst to normalize the valuation of a company. A lot of people in the financial space use the price-to-earnings (P/E) ratio to derive a company's value, above and beyond its market capitalization. However, a company's P/E ratio does not always provide a full picture.
Since it only takes into account market capitalization and profits, it can make a public equity look expensive compared to other companies when in reality, it's not. It's possible to normalize a company's valuation by taking the EBITDA-to-enterprise value rather than the P/E ratio. This allows the stock price of public companies to be better evaluated for investment purposes.