Equity value, commonly referred to as the market value of equity or market capitalization, can be defined as the total value of the company that is attributable to equity investors. It is calculated by multiplying a company’s share price by its number of shares outstanding.
What is Equity Value?
To calculate equity value from enterprise value, subtract debt and debt equivalents, non-controlling interest and preferred stock, and add cash and cash equivalents. Equity value is concerned with what is available to equity shareholders. Debt and debt equivalents, non-controlling interest, and preferred stock are subtracted as these items represent the share of other shareholders. Cash and cash equivalents are added as any cash left after paying off other shareholders are available to equity shareholders.
Market Value of Equity vs Book Value of Equity
The equity value of a company is not the same as its book value. It is calculated by multiplying a company’s share price by its number of shares outstanding, whereas book value or shareholders’ equity is simply the difference between a company’s assets and liabilities. For healthy companies, equity value far exceeds book value as the market value of the company’s shares appreciates over the years. It is always greater than or equal to zero, as both the share price and the number of shares outstanding can never be negative. Book value can be positive, negative, or zero.
Basic vs Diluted Equity Value
Basic equity value is simply calculated by multiplying a company’s share price by the number of basic shares outstanding. A company’s basic shares outstanding can be found on the first page of its 10K report. The calculation of basic shares outstanding does not include the effect of dilution that may occur due to dilutive securities such as stock options, restricted and performance stock units, preferred stock, warrants, and convertible debt.
A section on these securities can also be found in the 10K report. The dilutive effect of these securities can be calculated using the treasury stock method. To calculate the diluted shares outstanding, add the additional number of shares created due to the dilutive effect of securities on the basic securities outstanding.
Diluted Equity Value
Since all in the money securities are paid off by the buyer during an acquisition, from a valuation perspective, diluted shares outstanding should be used when using equity value or calculating enterprise value as it more accurately determines the cost of acquiring a firm. Furthermore, once the buyer pays off these securities, they convert into additional shares for the buyer, further raising the acquisition cost of the company.
Equity Value vs Enterprise Value
It is very important to understand the difference between equity value and enterprise value as these are two very important concepts that nearly always come up in finance interviews. Simply put, enterprise value is the value of a company’s core business operations that is available to all shareholders (debt, equity, preferred, etc.), whereas equity value is the total value of a company that is available to only equity investors.
Enterprise Value
To calculate enterprise value from equity value, subtract cash and cash equivalents and add debt, preferred stock, and minority interest. Cash and cash equivalents are not invested in the business and do not represent the core assets of a business. In most cases, both short-term and long-term investments are also subtracted, however, this requires an analyst’s judgment and depends on how liquid the securities are. Debt, preferred stock, and minority interest are added as these items represent the amount due to other investor groups. Since enterprise value is available to all shareholders, these items need to be added back.