Think of enterprise value as the theoretical takeover price.
In the event of a buyout, an acquirer would have to take on the company's debt but would pocket its cash. EV differs significantly from simple market capitalization in several ways, and many consider it to be a more accurate representation of a firm's value. The value of a firm's debt, for example, would need to be paid by the buyer when taking over a company, thus EV provides a much more accurate takeover valuation because it includes debt in its value calculation. (Investopedia)
Enterprise Value of a Firm
EV of a Firm
= Market Capitalization + Debt + Minority Interest - Cash - Other Non-Operating Assets.
Minority Interest is the result of the consolidation of the subsidiary company's account and it doesn't belong to the common shareholders of the company. The market value of MI is obtained by multiplying its book value by an appropriate price-to-book value.
The other non-operating assets such as investment in other companies, listed or non-listed, money market funds, investments in associates, etc. are treated in a similar way as cash or cash equivalent as they can be sold without impacting its core business.
Debt and cash
Debt and cash can have an enormous impact on a company's enterprise value.
Hence, when evaluating the fair price of a company or comparing companies, a better measure of value is the enterprise value divided by the EBIT or the operating income, instead of the too simplistic or flawed PE ratio.
EBIT Multiple = EV/EBIT
For an ordinary firm, an EBIT multiple of less than 8 may be considered as cheap.
For a high growth company, an EBIT multiple of 15 may be considered as fairly valued.
For HIGHLY INDEBTED businesses, the EBITDA is often used by all capital providers to have an idea of the
This valuation metric resembles cash flows and is also useful for companies with temporary negative earnings.
It is also a quick and dirty way for a Leverage Buy Out to value a target and to see how much leverage could slap on a company and still service the debt.
An EBITDA multiple of less than 11 for an ordinary company may be considered cheap.
Additional notes:
Valuation of a company at its firm level based on enterprise value.
Enterprise value looks at the value of the entire firm, for capitals both provided by equity shareholders and by the debt holders, and at the same time separating those assets not required or not used for the core operations of the business.
It is important to understand enterprise value and use it for valuing an investment for potentially better outcome.
For a company
However, many companies have
The simplistic PE ratio is useful as crude screening tool, but it has a serious limitation of ignoring the balance sheet items. This can materially misrepresent the earnings yield of a business.
The EBITDA figure is not normally listed in the Income Statement, but we can add the depreciation and amortization figures in the cash flows statement to EBIT or operating income.
EBITDA = EBIT + Depreciation and Amortization
EBITDA Multiple = EV/EBITDA
Reference:
The Complete VALUE INVESTING Guide That Works by K C Chong
(Pages 246 - 251)
In the event of a buyout, an acquirer would have to take on the company's debt but would pocket its cash. EV differs significantly from simple market capitalization in several ways, and many consider it to be a more accurate representation of a firm's value. The value of a firm's debt, for example, would need to be paid by the buyer when taking over a company, thus EV provides a much more accurate takeover valuation because it includes debt in its value calculation. (Investopedia)
Enterprise Value of a Firm
EV of a Firm
= Market Capitalization + Debt + Minority Interest - Cash - Other Non-Operating Assets.
Minority Interest is the result of the consolidation of the subsidiary company's account and it doesn't belong to the common shareholders of the company. The market value of MI is obtained by multiplying its book value by an appropriate price-to-book value.
The other non-operating assets such as investment in other companies, listed or non-listed, money market funds, investments in associates, etc. are treated in a similar way as cash or cash equivalent as they can be sold without impacting its core business.
Debt and cash
Debt and cash can have an enormous impact on a company's enterprise value.
A) EBIT MULTIPLE
Hence, when evaluating the fair price of a company or comparing companies, a better measure of value is the enterprise value divided by the EBIT or the operating income, instead of the too simplistic or flawed PE ratio.
EBIT Multiple = EV/EBIT
For an ordinary firm, an EBIT multiple of less than 8 may be considered as cheap.
For a high growth company, an EBIT multiple of 15 may be considered as fairly valued.
B) EBITDA Multiple
For HIGHLY INDEBTED businesses, the EBITDA is often used by all capital providers to have an idea of the
- earnings available at their disposal for investments and interest payment, as well as
- comparison among companies in the similar industry.
This valuation metric resembles cash flows and is also useful for companies with temporary negative earnings.
It is also a quick and dirty way for a Leverage Buy Out to value a target and to see how much leverage could slap on a company and still service the debt.
An EBITDA multiple of less than 11 for an ordinary company may be considered cheap.
Additional notes:
Valuation of a company at its firm level based on enterprise value.
Enterprise value looks at the value of the entire firm, for capitals both provided by equity shareholders and by the debt holders, and at the same time separating those assets not required or not used for the core operations of the business.
It is important to understand enterprise value and use it for valuing an investment for potentially better outcome.
For a company
- without much cash and debt, and
- without those non-operating one-time-off items,
However, many companies have
- substantial amount of cash or debts in their balance sheets, and
- often with some extra-ordinary gain/loss or other one-time-off items,
The simplistic PE ratio is useful as crude screening tool, but it has a serious limitation of ignoring the balance sheet items. This can materially misrepresent the earnings yield of a business.
The EBITDA figure is not normally listed in the Income Statement, but we can add the depreciation and amortization figures in the cash flows statement to EBIT or operating income.
EBITDA = EBIT + Depreciation and Amortization
EBITDA Multiple = EV/EBITDA
Reference:
The Complete VALUE INVESTING Guide That Works by K C Chong
(Pages 246 - 251)
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