Enterprise value (EV) is an important metric in value investing, because it does away with the value of cash on hand to see what the intrinsic value (as seen by the markets) of a firm currently is.
The calculation is simple; you add up the market value of common stock, preferred equity, debt, and minority interest, and then subtract cash and investments.
The idea of this is that you want to get together a calculation of the total market investment in the firm minus its liquid asset value, since cash on hand with Apple (AAPL) or IBM (IBM) has the identical value.
To get the enterprise value of Apple, we would need to look at its total capital structure. This includes its market cap (around $600 billion), its preferred stock ($0 billion), its debt ($105 billion), and its minority interests ($0). Add that up, and we get $705 billion.
Now subtract the cash and short-term investments/assets ($76 billion). That gets us to $629 billion.
Note that other estimates of EV may vary depending on which assets you consider part of the enterprise and which are highly liquid investments that the company’s operations do not rely on. Some assets are clearly an important part of the firm’s operation, such as its $177 billion in long-term investments and its $22 billion in property, plant, and equipment, although the $8 billion “other assets” category may or may not be considered a part of the enterprise.
The leeway in calculating EV is important. If you go to AAPL’s “key statistics” page on Yahoo Finance you are given a specific number: $633.68 billion, which many retail investors will treat as gospel. However, as the footnote to this measure indicates, this number is a calculation made by algorithims: “Data derived from multiple sources or calculated by Yahoo! Finance”. This is in itself an interpretation of accounting data, and not accounting itself.
With this in mind, we might want to consider whether we think the EV is higher and lower by trying to figure out exactly which parts of the company’s assets are being taken into account as part of the enterprise, and which are not. When we have done that and found an EV that we agree on, we can then make several ratio metrics, such as EV/Revenue, EV/EBITDA, or EV/Earnings. Yahoo gives us an EV/Rev of 2.7 and an EV/EBITDA of 7.65. With our numbers we get an EV/Rev of 2.68 and an EV/EBITDA of 7.65—pretty much the same figures.
This tells us a couple things:
- The market is pretty efficient about Apple (no real surprise there, considering how much attention the stock gets) and
- There is little opportunity here to capitalize on a major market mispricing.
Extending this method to less liquid, less closely analyzed stocks, we may find value in low EV/Rev and EV/EBITDA multiples that are not being fully recognized by the market. Or we may want to take the EV metric and apply it to Apple’s biggest competitors (GOOG, MSFT, etc.) and see if there’s a major discrepancy that could indicate one stock is overvalued and another is not.
This exercise demonstrates the importance of using several metrics to look at a stock. Here we are looking at exactly how much money Apple needs entrenched in its operations to make its revenue and earnings—a key consideration when determining the value of the company as a whole. While it can’t be used by itself, having this tool in your toolbox will help you be a smarter investor, and avoid making big mistakes in the market.