Enterprise Value (EV) Vs. PE multiple

Q&A: Questions & Answers Investing Basics Q&A
1

In general, which multiple would an investor choose EV or PE multiples?

  1. EV takes debt in consideration. Eg: EV= M.Cap + Debt - Cash (short formula), where as PE doesn’t take debt into huge consideration.

  2. Again another question comes to mind in book-value/share price. Why there is huge difference between book value and Enterprise Value (EV).

Thanks
Bharathi

@ seniors: I don’t know whether there is similar topic is available or not.If there is please delete this post. thanks.

2

There are no hard and fast rules when choosing multiples, obviously. If there were, everyone would use the same metric and there would be no need for any other metric ! Important thing is to find truly comparable companies and use the same metric to compare. Different companies run their operations differently, and also use debt differently, so while they may be equivalent on one metric, they may diverge on another. One needs to understand what the metric means to the operations and future sustainability of the company. There are some industries where some metrics are more common e.g. for financial services companies, price-to-book value is looked at more closely; but that does not mean other metrics are ignored.

As to your second question, book value is a pure accounting number while EV depends on how the market is viewing that company which is reflected in the share price. Book value is a measure of the past, the journey the company has already completed, whereas share price typically is a measure of the company’s future.

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3

Help me with the below understanding…

  1. If EV> MCap does that mean even though co is trading at x price but in reality buying a stock is actually costlier than what the ticker shows. So basically its costlier than what we think. Huge debt pushes EV>MCap thus owning in true sense gets costlier/ riskier
  2. If EV < MCap then , the company is actually selling cheaper than what the daily ticker shows.Huge cash reserve makes EV< MCap, so owning is actually turns cheaper/beneficial
  3. Should we compare P/E of 2 companies X & Y. Then compare EV /E of X & Y. Finally lower EV/E is relatively cheaper. Given every other factor is constant. Theoretically.

Is my understanding in the right direction…I wonder why we call it Enterprise Value…rather it should be enterprise Cost.

Value is neither in MCap nor in EV…its rather a price or cost to own…isn’t it ?