Why you should focus on enterprise value - MoneyWeek Videos

[Music] hi in this video I'm going to look at two investment terms market cap and Enterprise Value and these are two ways of measuring the value of a company and I'm going to explain what they mean and I'm going to show why I think Enterprise Value is actually the more useful term even though market cap is probably better known so I'm going to start by explaining what market cap means going to use the example of unil so right now in unil there are 2.84 billion shares in issue so what that means is if you cook all the shares on individuals owned by fund managers owned by Pension funds all of them added them all up you'd have 2.84 billion sh and just before I started filming this video the UN L share price was £489 so if we multiply these two together the share price and the number of shares in issue we get unilever's market cap which is 70.7 billion so if I was some massive American company that wanted to buy un L I'd need to pay in theory I'd need to pay the shareholders 7.7 billion that's the stock market value of unil lever right now or the market cap and market cap by the way stands for market capitalization it's the stock market value of the company that's fine now Enterprise Value adds in one extra uh factor into the equation and that's un lever's debt and the best way to measure debt is net debt so net debt is when you look at how much debt a company has short-term debts long-term debts you also look at how much cash unil has it in its bank account you take the cash away from the debt you get un's net debt and in the last published accounts unilever's net debt was 9.77 billion that's the net debt and actually if I wanted to buy a unil lver I'd need to pay 70.7 billion to the shareholders the market cap but I'd also need to pay off un lever's creditors so I'd need to pay off the net debt which is 9.77 billion and that's how you get Enterprise Value because Enterprise Value is market cap plus net debt and so in this example unilever's Enterprise Value is 70.7 plus 9 sorry 9.77 which equals 8.47 billion pound so the market cap of unila is 70.7 the ENT price value is 80.4 s because if I wanted to buy unil I'd have to pay the 70 billion to the shareholders the 9.7 billion to the creditors my total cost would be 8.47 billion that's the Enterprise Value now of course not all companies have net debt some companies have more cash than they have debt so they have net cash rather than net debt so to look at that in a bit more detail let's do another example and we'll do some imag companies this time we're going to do two companies we're going to call one company a and one Company B and these two companies they're really similar they operate in a similar business area and they both have market cap of 10 billion they both have a billion shares in issue they both have A10 pound share price and they both made profits last year of 500 million pound which means that the earnings per share is 50p now if you don't know what earnings for share means we've looked at it in another video on price earnings ratios and earnings per shares I don't have time to look at it now so if you can go and find the other video and that will explain what EPS means so again exactly the same they've both got EPS of 50p each that's just another measure of profit which means the price earnings ratio is 20 for both companies and once again the video on the PE ratios will explain what that all means if you don't if you don't know about that so here up till now both companies are absolutely identical and even they're even more identical because profit in both companies has been growing at the the same rate for the last 5 years but there's one big difference and that's in terms of debt and Cash Company a has more debt than Cash Company B has more cash than debt so company a has net debt of 2 billion whereas Company B has net cash of two billion so we know to calculate the Enterprise Value we say market cap plus net debt so that's 12 billion that's 10 billion plus 2 billion gives us an Enterprise Value of1 billion when you got net cash you say market cap and you take away the net cash now that I know that can seem counterintuitive it did when I first discovered this concept A few years ago and but think of it this way if you're buying Company B you have to pay 10 billion to the shareholders once You' bought the company you have two billion sitting in the bank account you can whip that two billion out so the effective cost of buying the company which is the Enterprise Value is 8 billion pound but if you're going to buy company a you pay 10 billion to the shareholders then you've got to pay off the creditors so that's another two billion so the Enterprise value of the company is 12 billion and suddenly it's clear that Company B here with a much lower Enterprise Value is much cheaper than company a here with a 12 billion Enterprise Value and you would never have known that if you just looked at the market cap here if you just looked at the profits if you just looked at the price earnings ratio so that's why I think Enterprise Value is a really important concept it really helps you understand better whether a company is cheap or not and it can help you buy the shares that are really likely to grow and be successful Investments often because they've got healthy cash Holdings in another video I'm going to look again at Enterprise Value and see how to compare Enterprise Value with various measures of profit but until then um good luck with your investing and I'll see you next time

Channel: MoneyWeek

Views: 23,729

Keywords: deals, ratios, losses, inflation, bank, payments, claims, successful, Dividend, stocks, shares, Overtrading, profit, loss, Bid, offer, spreads, Currency, credit, Trading, Trade, Tax, trade, economy, whiteboard, Banking, profits, Accounting, Asset, Purchase, Reverse, QE, enterprise value, investing, investors

Id: 1wUuScJ1nRc

Length: 8min 37sec (517 seconds)

Published: Mon Nov 25 2013