Enterprise value can be thought of as a private market valuation for the company. When a buyer purchases a company in the private market, he has to pay for the company equity (including common stock, preferred shares, minority interest, etc – learn about common stock vs preferred stock), he has to pay off all the debt, but in return the buyer gets the cash the company has in its bank accounts and other cash equivalents in form of securities and other liquid assets.
Therefore, Enterprise Value can be expressed as
Enterprise Value (EV) = Market Value + Preferred Stock + Minority Interest + Debt – Cash and Cash Equivalents
Should You Use Enterprise Value Instead of Market Value
In many ways, the Enterprise Value indicates the true value of the company better than the market value (which refers to just the common stock part of the capital structure).
See also: Market terms
Enterprise value is a balance sheet based metric and is important to conservative investors who depend on fundamental analysis of stocks for their investment decisions.
Many financial ratios that are based on Market Value can also be expressed in terms of the Enterprise Value. For example, EV/EBIT is similar to the P/E ratio. For value investors, enterprise value gets closer to the true value of the company as value investors train themselves to think like a business owner, rather than merely a stock speculator.
Another thing value investors look out for are the companies that have a negative enterprise value. As you can see from the equation, this is possible if and only if the company has more cash on the books than the sum of its equity (all variants) and debt. Or put in other words, this company can be purchased in its entirety for no money at all. In fact, you can take the cash on the company books, pay off the creditors and you will have enough left over to pay yourself back and some more. Finding a company like this is quite rare but is considered one of the holy grails of value investing.
Further Reading
