While both are crucial in assessing the financial health of an organization however, they differ in their views of the value of a company’s overall. 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, or market capitalization is the sum of the company’s outstanding shares listed on the stock exchange. It does not consider the company’s debt, and therefore it could give an inaccurate picture of a firm’s overall worth. Enterprise Value, however, adds the debt of a company to its equity and subtracts cash to provide a more complete view of its worth.
By adding a company’s debt, it 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. In the same way, subtracting a company’s cash reserves gives you an idea of its liquidity – the amount of cash available.
The EV/Market Cap ratio can be a quick and easy way to assess potential investments. However it’s not a substitute for due diligence or financial modeling. The EV to market cap ratio is also not a good measure of a firm’s relative worth in comparison to its peers since it doesn’t take into account the differences in the structure of capital and risk profiles.