Investment Valuation Ratios: Enterprise Value Multiple

This valuation metric is calculated by dividing a company's "enterprise value" by its earnings before interest expense, taxes, depreciation and amortization (EBITDA).

Overall, this measurement allows investors to assess a company on the same basis as that of an acquirer. As a rough calculation, enterprise value multiple serves as a proxy for how long it would take for an acquisition to earn enough to pay off its costs (assuming no change in EBITDA).

Formula:

Components:

Enterprise value is calculated by adding a company's debt, minority interest, and preferred stock to its market capitalization (stock price times number of shares outstanding). The data for the fictitious Zinzibar Holdings' enterprise value and earnings before interest, taxes, depreciation and amortization (EBITDA) were obtained from its stock quote, income statement and balance sheet as of December 31, 2017. By simply dividing, the equation gives us the company's enterprise multiple of 15.7, which means that it would take roughly 16 years for earnings (assuming EBITDA doesn't change) to pay off the acquisition cost of Zinzibar  Holdings.

Variations:

None

Commentary:

Enterprise value, also referred to as the value of the enterprise, is basically a modification of market capitalization, which is determined by simply multiplying a company's number of shares outstanding by the current price of its stock. Obviously, a company's stock price is heavily influenced by investor sentiment and market conditions, which, in turn, will be determined by a company's market-cap value.

On the other hand, a company's enterprise value, which is the metric used by the acquiring party in an acquisition, is a term used by financial analysts to arrive at a value of a company viewed as a going concern rather than market capitalization. For example, in simple terms, long-term debt and cash in a company's balance sheet are important factors in arriving at enterprise value - both effectively serve to enhance company's value for the acquiring company.

As mentioned previously, enterprise value considerations seldom find their way into standard stock analysis reporting. However, it is true that by using enterprise value, instead of market capitalization, to look at the book or market-cap value of a company, investors can get a sense of whether or not a company is undervalued.

For more information on acquisitions, see The Basics Of Mergers And Acquisitions, Mergers And Acquisitions - Another Tool For Traders and The Wacky World of M&As.

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