What is Enterprise value?
Why is it used by so many successful investors? And what are all the parts of the equation that make up this important method? All the answers coming up. It makes me feel happy to know that you’re reading this post.
I am excited for you to take this small step on your path to building your rapidly growing, highly diversified net worth one post at a time. The most straightforward way to value a company is by multiplying its share price by the total number of shares outstanding. This gives you what is called a company’s market capitalization, or market cap for short. Essentially, this tells you how much it would cost to buy every share of a company, to own 100% of that company.
This simple metric is what’s used when stocks are divided up by their size. But for a successful investor trying to fully understand the value of a company, not just what all the shares are worth, but the actual complete picture of a company’s value as an investment, this metric alone is not enough. And I hope that statement makes more sense to you in just a second.
But it’s because of this that more often than not, those successful investors use Enterprise Value, or EV for short. Enterprise Value more accurately represents the net impact, the bottom line effect as an investment on the portfolio of a potential acquirer who might take full ownership of a company. So if you’re buying shares in a company, actually becoming part owner in that company, that’s really how you should think about it. Because that’s what it is.Knowing what you would be out of pocket if you could just take over and purchase. The whole entire thing is not about perspective.
Putting yourself in the shoes of a potential acquirer, that’s valuable information, right? For your investment decision, it’s at least a more realistic representation than the market cap of the value the market is actually currently assigning to the company in question. Five variables go into this calculation, and when you think about each one, it’s obvious is more comprehensive and useful than the traditional market cap.
