Market Capitalization can be used to determine how much a company worth at a point of time, or "how big" a company is. However, there is a more accurate measure of a company's value, which is the Enterprise value.
The calculation of Market Cap is quite straight forward,
Market Cap = Share Price x Total Outstanding Shares
Enterprise Value (EV) is also not hard to calculate,
EV = Market Cap + Debt + Minority Interest + Preferred Shares - Cash & cash equivalent
All the figures except market cap can be obtained from the balance sheet.
EV is a theoretical takeover price. It is widely considered as a more accurate representation of a company's value.
When company A wishes to takeover or acquire company B, it needs to:
- pay company B's ordinary shares holders (market capitalization)
- pay company B's total debt
- pay company B's minority interest shareholders
- pay company B's preferred shares holders
However, company A does not need to pay for company B's cash. It will pocket the cash.
After obtaining the EV, we can calculate a company's Enterprise Value Multiple (EVM), which is one of the investment valuation ratio like the more commonly used PE ratio.
EVM = EV / EBITDA
EBITDA = Earning Before Interest, Tax, Depreciation & Amortization
EVM roughly tells how long it would take for an acquisition to earn enough to pay off its cost, assuming that there is no change in its annual EBITDA.
If EVM is 10, then it will take 10 years. Thus, the lower the number the better it is.
EVM might be a better valuation ratio compared to PE ratio as it includes a company's earning, debt and cash into the valuation, while PE ratio is only about a company's earning.
Like any other financial ratios, it is best to compare with peers and historical data.
Hello, just want to confirm with you, how do you calculate EBITDA.
ReplyDeleteEBIT = operating profit as shown in income statement.
Then, EBITDA = EBIT plus "Depreciation and amortisation" as shown in the cash flow statement?
CT Yap, I add in the Depreciation & Amortization value found in operating cash flow statement to EBIT to derive the EBITDA. Am I right?
ReplyDeleteBursa D, that is the question I want to ask you. Haha
ReplyDeleteSeem like it's what you said. I hardly find any info in internet.
Hi, Bursa D. I would like to know:
ReplyDelete1. What is the difference in between minority shareholders and preferred shareholders?
2. Is total debt equal to total liabilities?
Thank you for your precious time.
Kin Khuen,
ReplyDelete1) Definition from Investopedia:
Minority shares:
A significant but non-controlling ownership of less than 50% of a company's voting shares by either an investor or another company.
Preferred shares:
A class of ownership in a corporation that has a higher claim on the assets and earnings than common stock. Preferred stock generally has a dividend that must be paid out before dividends to common stockholders and the shares usually do not have voting rights.
2) In term of EV calculation, I think total debt is not total liabilities, it's total borrowings.
Oh i see. However based on the (http://www.readyratios.com/reference/market/enterprise_value_ev.html) the debt shall exclude trade creditor amount, any idea why?
DeleteSince i can found amount of minority interest in balance sheet, where can i locate the amount of preferred shares?
Thanks alot.
Yes, debts here are only borrowings/loans, and shall exclude trade creditors (payables), may be it's part of business operation.
DeleteI think preferred shares should be in the equity part of balance sheet. If we can't see it there that means the company has no preferred shares.