Investing in the stock market may seem like a complex process, from the outside. You need to value companies based on several metrics such as revenue, profit margins, and cash flows, among others. It's also imperative to know specific terms and ratios which will help you evaluate publicly listed companies.
One of the most common terms used to analyze a company's financial health is enterprise value (EV). So, what is enterprise value, and how is it calculated? Let's find out with the help of an example.
Exxon Mobil (NYSE: XOM) is among the most prominent companies trading on the S&P 500 index in terms of enterprise value. At the time of writing, Exxon Mobil's enterprise value stands at $423 billion. EV measures the total value of a company and is considered a more inclusive alternative to market capitalization.
The market cap is obtained by multiplying the company's stock price with its total number of outstanding shares. Exxon Mobil's market cap is currently $382 billion, given its stock price of $89.03 and an outstanding share count of 4.30 billion.
In addition to the market cap, the enterprise value also calculates a company's cash balance and total debt, which are part of its balance sheet.
So, the formula to calculate the enterprise value is:
Enterprise value = Market Cap + Debt - Cash
Exxon Mobil ended 2021 with $4.27 billion in loans payable, while its long-term debt stood at $43.42 billion. It also reported a cash balance of $6.8 billion. So, Exxon Mobil's enterprise value is $422.9 billion ($382 billion + $4.27 billion + $43.42 billion - $6.8 billion).
Enterprise value provides investors with information about the liquidity position of a company. It is also considered the theoretical buying price of a company in the case of an acquisition. So, if someone were to purchase Exxon Mobil, they would also have to service the latter's debt balance, which is close to $48 billion --a portion of which can be paid by the cash available on the balance sheet.
A company's cash reserves lower its acquisition cost. So, if you acquire Exxon Mobil for its market cap of $382 billion, you also have access to its cash balance of $6.8 billion, suggesting the effective acquisition cost is around $375 billion.
Alternatively, debt is an added cost as it's imperative to pay the company's shareholders and creditors to complete the acquisition.
If a company's cash balance is higher than its outstanding debt, the enterprise value will be lower than its market cap.
Like most other metrics, the enterprise value should not be viewed in isolation. For example, capital-intensive companies in the energy and utilities sector will have higher debt balances to support expansion plans.
In addition to Exxon, energy companies such as Chevron and NextEra Energy have debt balances of $29.3 billion and $60 billion respectively.
On the other hand, tech companies are asset-light and may have negligible debt on their books. For example, Arista Networks and Fortinet have negligible debt on their balance sheet.
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