Enterprise value is what it would cost to buy a company outright: market capitalisation plus total debt, minus cash. Buying every share does not buy the business free and clear, because the debt comes with it and the cash comes with it. EV accounts for both.
Why the adjustment matters
If you bought all the shares, you would inherit the obligations. The debt has to be repaid or refinanced, so it is part of the price. The cash sitting on the balance sheet is yours the moment you own the company, so it reduces the price. That is the whole logic.
Worked example
Two companies each trade at a $2,000M market cap and each generate $250M of operating profit. Company A holds $500M of cash and no debt. Company B holds $100M of cash and $800M of debt.
A: EV = $2,000M − $500M = $1,500M → EV/EBIT = 6.0×
B: EV = $2,000M + $800M − $100M = $2,700M → EV/EBIT = 10.8×
Identical P/E ratios, and one is nearly twice as expensive for the same earning power. A screen built on market cap treats them as equivalent.
Where it changes the answer most
- Cash-rich companies look expensive on P/E and reasonable on EV multiples, because the cash is doing nothing for earnings while inflating the price you appear to pay.
- Heavily indebted companies look cheap on P/E and expensive on EV, which is the more honest reading and the one that catches leveraged businesses masquerading as bargains.
- Comparing across capital structures. Two competitors financed differently cannot be compared on P/E at all. On EV multiples they can.
EV/EBITDA, and its problem
The most common EV multiple pairs enterprise value with EBITDA, on the logic that both ignore financing. It is genuinely useful for comparing capital-intensive companies across different debt loads.
Its weakness is EBITDA itself. Adding back depreciation treats the wearing out of assets as though it were not a cost, which is defensible for a software company and absurd for one that must replace machinery every decade. Charlie Munger's objection was blunt and correct: for many businesses, depreciation is the truest expense there is. Pair EV with EBIT or with free cash flow when the company owns a lot of hard assets.
What to include
Total debt means short and long term together. Cash usually means cash and equivalents, though strictly only cash above what operations require should be subtracted, since a business needs some to function. Preferred stock and minority interests are added by convention because they are claims ahead of common shareholders. Pension deficits arguably belong too, and most data providers ignore them.
Providers differ, so two screeners will give two enterprise values for the same company. Pick a method, apply it consistently, and do not compare figures pulled from different sources.
Which multiple fits depends on the phase
EV multiples work where earnings exist and mislead where they do not. Phase Check reads any US-listed company's financials, places it on the lifecycle, and names the valuation approach that fits.
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Frequently asked questions
Related
- Market cap, the number enterprise value corrects
- P/E ratio, the multiple that ignores capital structure
- How to read a balance sheet, where the debt and cash come from
- Investing glossary, every term used above, defined in plain English