For the last few days, you would have probably seen headlines such as “Tesla is worth more than Ford – and GM is in sight” and people arguing about whether Tesla is worth being valued at the same level as GM and Ford.  All those discussions highlight a major issue with how people incorrectly value companies.

Imagine someone wants to buy Tesla, or Ford, or GM today.  The price you would have to pay is not just the market capitalisation, and you have to repay the debt and consider the cash in the books.  The concept we should be looking at is enterprise value.  We at CityFALCON run London Value Investing Club, and we make sure that we consider enterprise value when performing fundamental research of companies.

Please note that the purpose of this post is to not discuss whether Tesla is a good or bad investment at this stage but to explain the importance of looking at the enterprise value.

Here is a comparison of the enterprise value of these companies:

Source: Google Finance (6 April 2017)

As you can see above, General Motors is worth twice the enterprise value of Tesla.

What is Enterprise Value (EV)?

Enterprise value is an economic measure reflecting the market value of a business. It is a sum of claims by all claimants: debtholders (secured and unsecured) and shareholders (preferred and common). Enterprise value is one of the fundamental metrics used in business valuation, financial modeling, accounting, portfolio analysis, and risk analysis.

What are the pitfalls of not considering EV and focusing only on market capitalisation of stocks?

Companies can raise capital in different ways — through equity, debt or convertible debt. Also, some companies generate a ton of cash and may or may not give out dividends. By focusing only on market capitalisation, investors are not considering the entirety of the business. If you are comparing companies with different capital structures, do look at the enterprise value!

Why do some analysts and media then focus only on market capitalisation?

Simple answer — market capital is easy to find, calculate and track on a continuous basis.  EV calculations are not easily available or usually not updated on a regular basis.  When doing my research, I calculate the EV myself by looking at the balance sheet of companies

Examples of companies with negative net debt (debt – cash) that you’re probably overvaluing by looking at only the market capitalisation

Source: Google Finance (6 April 2017)

Examples of companies with high debt that you’re probably undervaluing by looking at only the market capitalisation

Source: Google Finance (6 April 2017)

You can track fundamental stories including tweets for Tesla, GM, and Ford Motors on our platform’s financial news here.