1. Investment Valuation Ratios: Introduction
  2. Investment Valuation Ratios: Per Share Data
  3. Investment Valuation Ratios: Price/Book Value Ratio
  4. Investment Valuation Ratios: Price/Cash Flow Ratio
  5. Investment Valuation Ratios: Price/Earnings Ratio
  6. Investment Valuation Ratios: Price/Earnings To Growth Ratio
  7. Investment Valuation Ratios: Price/Sales Ratio
  8. Investment Valuation Ratios: Dividend Yield
  9. Investment Valuation Ratios: Enterprise Value Multiple

By Richard Loth (Contact | Biography)

This valuation metric is calculated by dividing a company's "enterprise value" by its earnings before interest expense, taxes, depreciation and amortization (EBITDA).

Overall, this measurement allows investors to assess a company on the same basis as that of an acquirer. As a rough calculation, enterprise value multiple serves as a proxy for how long it would take for an acquisition to earn enough to pay off its costs (assuming no change in EBITDA).

Formula:


Components:

Market Capitalization
($67.44 x 247.8 MM)
$16,712
-- --
Debt 82
Minority Interest 2
-- $16,796
Less Cash/Cash Equivalents (233)
Enterprise Value $16,563


Enterprise

value is calculated by adding a company's debt, minority interest, and preferred stock to its market capitalization (stock price times number of shares outstanding). The data for Zimmer Holdings' enterprise value and earnings before interest, taxes, depreciation and amortization (EBITDA) were obtained from its stock quote, income statement and balance sheet as of December 31, 2005. By simply dividing, the equation gives us the company's enterprise multiple of 15.7, which means that it would take roughly 16 years for earnings (assuming EBITDA doesn't change) to pay off the acquisition cost of Zimmer Holdings.

Variations:
None

Commentary:
Enterprise value, also referred to as the value of the enterprise, is basically a modification of market capitalization, which is determined by simply multiplying a company's number of shares outstanding by the current price of its stock. Obviously, a company's stock price is heavily influenced by investor sentiment and market conditions, which, in turn, will be determined by a company's market-cap value.

On the other hand, a company's enterprise value, which is the metric used by the acquiring party in an acquisition, is a term used by financial analysts to arrive at a value of a company viewed as a going concern rather than market capitalization. For example, in simple terms, long-term debt and cash in a company's balance sheet are important factors in arriving at enterprise value - both effectively serve to enhance company's value for the acquiring company.

As mentioned previously, enterprise value considerations seldom find their way into standard stock analysis reporting. However, it is true that by using enterprise value, instead of market capitalization, to look at the book or market-cap value of a company, investors can get a sense of whether or not a company is undervalued.

For more information on acquisitions, see The Basics Of Mergers And Acquisitions, Mergers And Acquisitions - Another Tool For Traders and The Wacky World of M&As.

Click here to return to the Financial Ratio Tutorial main menu.


Related Articles
  1. Investing

    Explaining Enterprise Multiple

    The enterprise multiple is a ratio used to value a company as if it was going to be acquired.
  2. Investing

    Value Investing Using The Enterprise Multiple

    This simple measure can help investors determine whether a stock is a good deal.
  3. Investing

    The Difference Between Enterprise Value and Equity Value

    Enterprise value calculates a business’s current value, while equity value offers a snapshot of that business’s current and potential future value.
  4. Investing

    Introduction To Enterprise Value

    Learn how enterprise value can help investors compare companies with different capital structures.
  5. Investing

    Investment Banking Interview: What to Know

    There’s a few things to know before interviewing for an investment-banking job.
  6. Investing

    The Three Things Most Good Stocks Have In Common

    Uncover the three things most good stocks have in common: performance, profitability and value.
  7. Investing

    EBITDA: Challenging The Calculation

    This measure has a bad rap, but it's still a valuable tool when used appropriately.
  8. Investing

    Using Enterprise Value To Compare Companies

    Learn how enterprise value can help investors compare companies with different capital structures.
  9. Investing

    Free Cash Flow vs EBITDA: Which Should You Analyze?

    FCF and EBITDA are two ways of looking at the earnings of a business. EBITDA might be better for comparison purposes, while FCF is good for valuation.
  10. Markets

    McDonald's Stock: Capital Structure Analysis (MCD)

    Learn about the importance of capital structure, and what equity and debt capitalization measures can tell us about the performance of McDonald's Corporation.
Trading Center