Monday, February 21, 2011

Enterprise Value

One valuable lesson I learned from The Little Book that Beats the Market is that market capitalization (of a stock) is only useful as a component in calculating enterprise value. Two companies with identical market capitalizations can have drastically different "values". Market capitalization just tells you (# of shares) x (current share price). Enterprise value tells you the (net) cost of buying the entire company at the current share price---when you buy, debt needs to be paid off and cash goes into your pocket. So, valuation metrics based on market capitalization miss an important aspect of valuation.

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