A:

Enterprise value and market capitalization (also known as market cap) each measure a company's market value. The two calculations are not identical, and the terms are certainly not interchangeable. However, each offers a peek at a company's overall value and a way to compare similar companies. These numbers are also helpful in determining a fair price to pay for shares of a particular company.

Market Capitalization: A Simplified Valuation Method

Market capitalization is the most simplified way to calculate a company's size, value and, consequently, its growth and risk outlook. This measurement assesses the value of a business based purely on stock. The calculation is a multiple of the stock's current share price and number of shares outstanding.

For example, if XYZ stock is trading at $14 per share and has 2 million shares outstanding, its market capitalization is $28 million. Market capitalization can also give you an idea of the growth and risk to expect from a particular stock. Companies are classified according to market capitalization in many instances. The broad categories are large-, mid- and small-cap. Generally, companies that are considered large cap see slower growth but pose far less risk than small-cap stocks, which often experience accelerated growth, but at the cost of higher risk.

Market capitalization provides an idea of the size of the business and makes it easy to identify peers within a sector. It also demonstrates that share price alone is not a gauge of a company's overall value. Just because a stock has a high share price does not necessarily mean the company is worth more. A great example of this is Ford Motor Company (F), with a seemingly low share price of $13.03 on Jan. 11, 2018. However, Ford is a huge automaker. If you look at its market capitalization, which was about $52 billion, you can also see that the company is worth quite a bit.

Enterprise Value: A More Accurate Valuation

Market capitalization omits important factors in the overall valuation of a company.

For example, if a company were to be purchased, market capitalization would only reflect the cost to acquire the outstanding equity. In reality, the new owner would also become responsible for all outstanding debt.

Enterprise value (EV) calculates a more accurate value of a company, taking into consideration its debt obligations. Though it requires substantially more detailed information than simple market cap, enterprise value gives a much more comprehensive view of a company's worth.

To calculate enterprise value, add market capitalization to the company's outstanding preferred stock and all debt obligations, then subtract cash and cash equivalents. 

Enterprise value is very commonly used in value investing to identify undervalued companies. A company with good earnings and possibly even a solid dividend may sound very appealing to many investors. This company might also have a large market capitalization. However, if you look further and calculate the company's enterprise value, you may find serious debt obligations that could pose a problem. If you compare the enterprise value of an equally well-earning company and find it has a higher enterprise value, purchasing the latter stock would be a better overall value.

RELATED FAQS
  1. What is the difference between market capitalization and market value?

    Understand the difference between market capitalization and market value, including the elements used for the calculation ... Read Answer >>
  2. What is the difference between market capitalization and equity?

    Understand the difference between market capitalization and equity, two primary measurements used to evaluate the worth of ... Read Answer >>
  3. How can I use market capitalization to evaluate a stock?

    Find out how market capitalization affects valuation in fundamental analysis, which valuation ratios use market cap and how ... Read Answer >>
  4. What is the difference between market capitalization and revenue?

    Understand the definitions of market capitalization and revenue, how each is calculated and how each reflects the value of ... Read Answer >>
Related Articles
  1. Financial Advisor

    Introduction To Enterprise Value

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

    What the Enterprise Multiple Tells Value Investors

    Learn how the enterprise multiple which looks at company debt and cash levels, in addition to its stock price, can be taken advantage of in value investing.
  3. Investing

    Ford Stock: Capital Structure Analysis (F)

    Learn where Ford is on its road to financial recovery, and how the company's capital structure contributes to the risk profile on investments.
  4. Investing

    What's A Company’s Worth, And Who Determines Its Stock Price?

    A company’s worth is the same as its market capitalization. Market capitalization is stock price multiplied by number of outstanding shares.
  5. Investing

    3 Reasons Enterprise Products Stock Could Rise (EPD)

    So far, 2015 has not been kind to shares of Enterprise Products Partners (NYSE: EPD). While the midstream energy specialist has routinely beaten the S&P 500 on a total return basis, its negative ...
  6. Investing

    Target Corp: WACC Analysis (TGT)

    Learn about the importance of capital structure when making investment decisions, and how Target's capital structure compares against the rest of the industry.
  7. Investing

    Disney Stock: Capital Structure Analysis (DIS)

    Learn about Disney's capital structure and why the company can afford to be more aggressive with its current level of debt exposure.
  8. Investing

    Cheap Stocks or Value Traps?

    The value of stocks that trade at less than cash per share can be deceiving.
  9. Investing

    Boeing Stock: Capital Structure Analysis (BA)

    Learn about Boeing's capital structure and how it used cash, debt and equity capital to finance a $6.7 billion stock repurchase program.
RELATED TERMS
  1. Enterprise Multiple

    Enterprise multiple is a measure (the company's enterprise value ...
  2. Equity Market Capitalization

    Equity market capitalization is the measure of the total market ...
  3. Return on Market Value of Equity - ROME

    Return on market value of equity (ROME) is a measure used to ...
  4. Value

    Value is the monetary, material or assessed worth of an asset, ...
  5. Earnings Per Share - EPS

    Earnings per share (EPS) is the portion of a company's profit ...
  6. Large Cap - Big Cap

    Large cap refers to a company with a market capitalization value ...
Hot Definitions
  1. Futures Contract

    An agreement to buy or sell the underlying commodity or asset at a specific price at a future date.
  2. Yield Curve

    A yield curve is a line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but ...
  3. Portfolio

    A portfolio is a grouping of financial assets such as stocks, bonds and cash equivalents, also their mutual, exchange-traded ...
  4. Gross Profit

    Gross profit is the profit a company makes after deducting the costs of making and selling its products, or the costs of ...
  5. Diversification

    Diversification is the strategy of investing in a variety of securities in order to lower the risk involved with putting ...
  6. Intrinsic Value

    Intrinsic value is the perceived or calculated value of a company, including tangible and intangible factors, and may differ ...
Trading Center