Equity vs Enterprise Value

If you are an investor, you wouldn’t be concerned about the type of products and services, as long as the company is making profits and is appreciating its share price. However, the company has to think about both the factors and how it has to take its business forward in the best possible way along with giving good returns to the investors.

In technical terms, the concept of serving the customers and ensuring good returns to the investors are considered separate, with both having their unique features and processes. The former is known through the enterprise value, and the latter is called equity value. Customers and investors are generally confused about the difference between enterprise value and equity value. This blog will define everything you need to under enterprise value vs equity value and help you make informed investment decisions.

What is Enterprise Value?

The enterprise value of a company is the total monetary value of all of the assets of the company, excluding cash. The enterprise value reflects how much a business is worth if it is to be sold to another company in the current market. Enterprise value is useful for other businesses and investors to compare companies with different capital structures as the capital structure does not affect a company’s total value.

Understanding Enterprise Value

A business grows through numerous processes, one of which can be mergers and acquisitions. A company can initiate a merger with a different company to create a new entity or acquire a different company to expand. In both cases, the company looks at the enterprise value of the other company before the deal is finalised.

When acquiring a company, the acquirer takes on the company cash along with company debt. However, the debt increases the cost of acquisition while the company cash decreases the cost, making enterprise value a vital factor for both companies.

Calculating Enterprise Value

Here is the formula to calculate the enterprise value of a company:

EV = (share price x number of outstanding shares) + total debt – cash

Here, total debt includes interest paid owing to preferred shares, shareholders and other instruments.

What is Equity Value?

Equity value is defined as the total value of the company’s shares along with any loans that the shareholders of the company have made available to the company. It is the value that is left for the company shareholders after the company has paid all the debt. The equity value is important for investors when they are evaluating a company and analysing its stock. It allows them to know about the current value of the company along with predicting its future value.

Understanding Equity Value

The principal behind equity value is to identify how much a company’s value affects its stock. An investor evaluates a company’s offerings to its investors and its equity model. When equity value is being calculated, the enterprise value gets added to non-operating assets, and then the debt net of cash available is subtracted. However, the total equity value can be further understood by considering the shares outstanding (common and preferred) and the total shareholders’ loans. The equity value fluctuates in nature and can fall or rise based on the company’s stock price in the stock market.

Calculating Equity Value

Here is the formula to calculate the equity value of a company:

Equity value = Enterprise Value – total debt + cash

Equity value = number of shares x share price

Enterprise Value vs Equity Value: How to use them for valuing a company?

When you look at the difference between enterprise value and equity value, you will realise that the enterprise value is used more widely than the equity value. It is because the enterprise value allows analysts to remove the capital structure from the valuation process. However, enterprise value is primarily used by investment banks who want to find the value of the whole business before advising their clients on the Merger or Acquisition of a different company.

Despite analysts using enterprise value more than the equity value, it is still an important technique used in equity research by investors. As investors want to buy individual shares of the company and not the entire business, they use equity value, its current company value and predict its future value based on how much the share price has the potential to appreciate.

Example of Enterprise value vs Equity value

Suppose you buy a house for Rs 50 lakhs. However, you do not want to pay all the amount in cash. Therefore, you take a loan of Rs 35 lakhs and pay the remaining Rs 15 lakhs as a down payment on the house.

In this whole transaction, the entire value of the house, i.e., Rs 50 lakhs, is the enterprise value, while your down payment of Rs 15 lakhs is the equity value. Hence, the enterprise value represents the total value for all the contributors and includes the equity holder (you) and the debt holder (the bank). Once you add both of their values, you get the enterprise value.

Final Word

The enterprise value reflects how much a company will get if it were to sell the entire company to anyone in the market. It is an important measure for companies who are looking to complete the process of Mergers and Acquisitions. Using the enterprise value, companies ensure that they don’t end up paying higher than what the acquiree company is worth.

On the other hand, equity value is a part of enterprise value that concerns the equity aspect of the company and reflects how much value the company can create if one is to buy the shares of the company. Now that you know the enterprise vs equity value and the difference between enterprise value and equity value, you can make better decisions while valuing companies.