Market Capitalisation vs. Enterprise Value: What Each Tells You

The Price Tag That Leaves Things Out

When people say a company is "worth ₹50,000 crore," they usually mean its market capitalisation: the share price times the number of shares. It is the most quoted number in markets, and it fairly answers one question: what do the shares cost?

It does not answer a different question: what does the business cost? If you bought every share of a company, you would also take on its debt, and you would also get its cash. Market cap ignores both.

That is why analysts look at enterprise value (EV) alongside market cap.

Two Measures, Two Questions

• Market capitalisation is the value of the equity. It belongs to shareholders only.
• Enterprise value is the value of the operating business to everyone with a claim on it, lenders and shareholders together.

Think of buying a house that still has a loan on it. The price you pay the seller is like market cap. But you also take over the loan. The full cost of the house is the price plus the loan, minus any cash the seller leaves behind in the house. That full cost is the enterprise value.

Building Enterprise Value Step by Step

Enterprise value = Market cap + Debt + Preference capital + Minority interest - Cash and non-operating investments

• Debt. Short-term and long-term borrowings, at book value unless the market value is very different.
• Preference capital. A claim that ranks ahead of ordinary shareholders.
• Minority interest. In consolidated accounts, the part of subsidiaries owned by others. Consolidated EBITDA includes all of those subsidiaries, so EV must include the minority's share too.
• Cash and investments. Cash, bank balances and liquid investments that the business does not need to run.

Some analysts also add lease liabilities and large unfunded employee obligations. More on that below.

A Worked Example: Same P/E, Different Price for the Business

Illustrative example. Two companies run identical businesses. Each earns EBITDA of ₹1,500 crore, has depreciation of ₹300 crore and pays tax at 25%. Both trade at a P/E of 10. The only difference is how they are funded.

• Company A has borrowings of ₹4,000 crore at 9% interest and cash of ₹500 crore.
• Company B has no debt and ₹2,000 crore of cash earning 7% interest.

On P/E, the two look equally priced. As businesses, they are not. Buying all of Company A, debt included, costs ₹9,800 crore. Buying all of Company B costs ₹8,050 crore for exactly the same operating business.

Company A's shares also carry more risk, because lenders are paid first. If anything, it deserves a lower P/E than Company B, not the same one.

Matching the Multiple to the Measure

The numerator and the denominator must belong to the same group of investors.

Mixing them, such as dividing market cap by EBITDA, compares a value that belongs to shareholders with a profit that belongs to everyone. It makes companies with heavy debt look cheaper than they are.

Adjustments That Trip People Up

• Leases. Since Ind AS 116 took effect in India in April 2019, most leases sit on the balance sheet as lease liabilities, and lease rent no longer reduces EBITDA. If you use EBITDA on this basis, include lease liabilities in EV. If you leave them out, airlines and retailers will look much cheaper than they are.
• Cash that is not free. Cash in a foreign subsidiary, cash pledged to lenders and cash needed for daily operations should not all be subtracted.
• Stakes in other companies. If EBITDA does not include an associate company's profit, treat the value of that stake as a non-operating asset and subtract it from EV.
• Free-float market cap. Index providers use free-float market cap, which leaves out promoter holdings. For EV, use the full market cap.
• Capital work in progress. Debt raised for a plant still under construction is already in EV, but the plant's future EBITDA is not yet in the denominator. The multiple looks high until the project starts earning.

Limits of Enterprise Value

For banks, NBFCs and insurers, debt is not just funding. It is raw material. Deposits and borrowings are what they lend out. EV makes little sense for them, so they are valued on price-to-book and return on equity instead.

Holding companies and conglomerates also need care. Much of their value can sit in listed stakes in other companies, which are better valued separately and added up. In India, such holding companies often trade well below the market value of their stakes, a gap usually called the holding company discount.

Habits for Using Both Measures

1. Use EV to compare operating businesses with different levels of debt.
2. Build EV from the latest consolidated balance sheet, with market cap taken on the same date.
3. Decide how to treat leases once, and apply the same choice to both EV and EBITDA.
4. Question every rupee of cash you subtract.
5. Never pair EV with net profit, or market cap with EBITDA.

The Reframe

Market cap is the price of the shares. Enterprise value is the price of the business. Before calling a company cheap, be sure which of the two you are looking at.