Both measures are useful in assessing a company’s financial health, however they offer different views of the business’s value. Understanding the difference between Market Cap and Enterprise Value can help you make informed purchasing decisions that are in line with your investment goals.
Market capitalization is the sum of value that a company can get from its outstanding shares that are listed on the stock exchange. It does not include a company’s outstanding debt, which can cause a false impression of the value of the company. Enterprise Value is a different approach. It adds the company’s debt to its equity and subtracts cash to provide an overall picture of its value.
By adding a company’s debt, it gives you an idea of the company’s financial obligations that have to be paid over time, as well as its capacity to invest in growth opportunities and pay dividends to shareholders. By subtracting the money of a company, it will give you an idea of its liquidity, or the amount of cash it has available.
The EV to Market Cap ratio is a quick way to screen companies for potential investments however it is not a way to replace due diligence or financial modeling. In addition the EV to Market Cap ratio is not the most accurate measure of a company’s worth in comparison to its peers, because it fails to account for the differences in each firm’s individual capital structures and risk profiles.