How Enterprise Value Differs from Market Cap
3 min read
When a company goes through a funding round, the news often talks about its updated valuation, aka how much it's worth. Value can be calculated in multiple ways, including market cap and enterprise value.
Let's unearth how enterprise value (EV) and market cap are different. That way, you can better understand the type of investment you're getting into.
Market cap, defined
Market capitalization, or market cap, is the total value of a public company's outstanding shares (aka shares that have been purchased on the public market).
Market cap is often listed on a company's stock chart. You can also calculate it by multiplying the number of outstanding shares times the market value of the share.
Because market cap goes off of market value, the number constantly fluctuates.
Public companies are often differentiated by their cap size, with values like micro cap, small cap, mid cap, large cap, and mega cap. Companies like Bumble (NASDAQ:BMBL) and Amazon (NYSE:AMZN) have mega cap stocks, with market cap values of $9.7 billion and $1.7 trillion, respectively. Or look at international large cap examples like Dubai Insurance Co. and Air Arabia for comparison.
How to calculate enterprise value
Enterprise value uses market cap as part of its equation, but that's not the whole story.
To calculate EV, you take the market cap and add total debt. This includes short- and long-term debt. Then subtract the company's liquidity, aka cash. Here's what the equation looks like:
Enterprise value = Market cap + Total debt − Cash
An easy way to think about enterprise value is that it's a theoretical price for which the company might be bought at the current moment.
The real difference between market cap and enterprise value
Market cap values a company based on equity alone, which means it's only a part of the picture. Enterprise value takes the whole organization into consideration.
In addition to market cap, enterprise value considers debt and cash.
Perhaps the biggest difference is that EV reflects a company's book value while market cap reflects its value as determined by investors. The value of a stock has to do with much more than numbers. It's sentiment and news and perceived performance—in addition to the actual balance sheet.
Which is better for investors to know: EV or market cap?
Many investors prefer to use enterprise value to make an educated decision about a stock. This is because it's a more comprehensive glance of a company's worth. By taking debt into consideration, you're getting a more accurate perception of what a company is really worth.
Still, market cap can be helpful in the short term. If a company's market cap starts to waver, it could indicate a potentially volatile period ahead. A strengthening market cap could indicate the ticker is a growth stock. There are plenty of scenarios for analysis, but knowing the difference between types of valuation like EV and market cap plays a big role in being a savvy investor.
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