Sunday, December 26, 2010

Enterprise Value - EV

I'm currently taking a marketing course for my pharmaceutical and healthcare executive MBA through St. Joseph's University Erivan K. Haub School of Business. As I take different courses during business school, I'll write about some of the things that I'm learning about business. One of the main reasons I wanted to get an MBA was to learn the language of business. Many of these words and acronyms were not in my regular vocabulary when I was in medical school. You can learn the language of business on your own, but I wanted structure and the ability to engage with other business-minded professionals. That's why I enrolled in business school.

This week, I thought I'd write about Enterprise Value or EV. What is EV and what are all those ratios like EV/Sales and EV/R? I took the following excerpts from Investopedia:

What Does Enterprise Value - EV Mean?

A measure of a company's value, often used as an alternative to straightforward market capitalization. Enterprise value is calculated as market cap plus debt, minority interest and preferred shares, minus total cash and cash equivalents.

Think of enterprise value as the theoretical takeover price. In the event of a buyout, an acquirer would have to take on the company's debt, but would pocket its cash. EV differs significantly from simple market capitalization in several ways, and many consider it to be a more accurate representation of a firm's value. The value of a firm's debt, for example, would need to be paid by the buyer when taking over a company, thus EV provides a much more accurate takeover valuation because it includes debt in its value calculation.

Enterprise-Value-To-Sales - EV/Sales

What Does Enterprise-Value-To-Sales - EV/Sales Mean?

A valuation measure that compares the enterprise value of a company to the company's sales. EV/sales gives investors an idea of how much it costs to buy the company's sales. This measure is an expansion of the price-to-sales valuation, which uses market capitalization instead of enterprise value. EV/sales is seen as more accurate because market capitalization does not take into account as well as enterprise value the amount of debt a company has, which needs to be paid back at some point. Generally the lower the EV/sales the more attractive or undervalued the company is believed to be.

The EV/sales measure can be negative when the cash in the company is more than the market capitalization and debt structure, signaling that the company can essentially be bought with its own cash.

The EV/sales measure can be slightly deceiving: a high EV/Sales is not always a bad thing as it can be a sign that investors believe the future sales will greatly increase. A lower EV/sales can signal that the future sales prospects are not very attractive. It is important to compare the measure to that of other companies in the industry, and to look deeper into the company you are analyzing.

Enterprise-Value-To-Revenue Multiple - EV/R

What Does Enterprise-Value-To-Revenue Multiple - EV/R Mean?

A measure of the value of a stock that compares a company's enterprise value to its revenue. EV/R is one of several fundamental indicators that investors use to determine whether a stock is priced well. The EV/R multiple is also often used to determine a company's valuation in the case of a potential acquisition. Other valuation multiples that investors looking at EV/R would likely consider include EV/EBITDA, P/E and P/BV. EV/revenue is most commonly expressed as a number in decimal form followed by an x, as in 2.6x.

Investors should compare EV/R for the company being analyzed to that of other public companies in the industry to get an idea of the company's relative financial health. For example, one electronics store's EV/R multiple should be compared to those of other electronics stores, not to those of food manufacturers or healthcare providers. This is true of any type of ratio analysis. Also, investors should always look at a variety of indicators, as no single indicator can provide an accurate picture of a company's performance.

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