Both measures are useful in evaluating a company’s financial health, but they offer different perspectives on a company’s value. Understanding the distinction between Market Caps and Enterprise Values can help you make informed buying decisions that are in line with investment goals.
Market Cap, also known as market capitalization is the sum of a company’s outstanding shares on the stock exchange. It does not consider a company’s debt, so it can provide an inaccurate picture of a firm’s overall worth. Enterprise Value is, on the other hand is a way to add a company’s debt to its equity, and subtracts its cash to provide a complete picture of a company’s value.
Adding a company’s debt gives you an idea of the firm’s financial obligations, which must be paid over time, as well as the ability of the company to invest in growth opportunities and pay dividends to shareholders. Also, subtracting a company’s cash will give you an idea of its liquidity, which is the amount of cash in its bank.
The EV/Market Cap ratio is an efficient and quick method to evaluate potential investments. However it is not a substitute for due-diligence or financial modeling. The EV to market cap ratio is also not a reliable gauge of a company’s worth in comparison to its peers as it does not take into consideration the differences in capital structures and risk profiles.