For decades, a company’s market cap was used in valuation ratios but it has a fatal flaw. It can be misleading for companies with piles of debt. So enterprise value emerged as an alternative.
The advantage of enterprise value is that it’s a closer approximation of what a business might cost if it was bought outright. When you buy a business, you get everything — the business, its assets, and its debts. So enterprise value includes the company’s market cap, plus its outstanding debts (including preferred stock), then subtracts out the cash.
Including debt can dramatically change the valuation of a company. A company might look cheap based on market cap alone. But if it’s sitting on piles of debt, it will look expensive based on enterprise value. It’s not perfect, but using enterprise value makes for a better comparison between different companies.
The value metrics below are built using enterprise value. All tests were run with the following setup: Continue Reading…