Enterprise value

Those who have studied valuation formally before will recognise the similarity between debt free cash free and another term used in finance: “enterprise value”. Both measures value the company including certain of its liabilities. This makes the two measures of company value very similar. The difference is that some valuation practitioners would involve a few more liabilities in their calculation of enterprise value.

For example, items that may not bear interest but still have to financed, such as a pension liability.

This makes the two concepts very similar.

DFCF includes debts.

Enterprise value includes debt and debt-like items.

Valuation course summary: DFCF and enterprise value

To summarise, debt free cash free valuation:

• Represents the valuation of a company with net debt removed;

• Is greater than the shares/ equity value for a company that has net debt (remember the 100 million DFCF against the 70 million shares value);

• Is often used in letters offering to buy a company; and

Is very similar to another term used in valuation: “enterprise value”.

Valuation training course: what is debt free cash free?

In this valuation course module Financial Training Associates explains the role of debt free cash free (DFCF) values in the sale and purchase of companies. The material is of interest to finance, law, accounting, banking and other professionals dealing with the purchase and sale of businesses.

• What is debt free cash free? Why is it used in company valuation?

• How does DFCF compare to shares/ equity valuation?

• Why is DFCF used in business valuation?

• What happens in a sale and purchase agreement?

• One of the main valuation methods: relative/ comparable company valuation

• The use of EBITDA multiples in comparable valuation

• Relative valuation : applying it in practice

• Overview of another main valuation method: discounted cash flow or DCF valuation

DFCF vs. enterprise value.

Heads of terms entered into between a seller and a buyer often state that the target company or business is to be acquired on a "debt free/cash free" basis. Similarly, if there are multiple potential buyers of a target business, the seller may insist that each bidder makes an offer on a "debt free/cash free" basis. It is therefore important to understand and agree upon the meaning of "debt free/cash free".

Typically, if a business is to be acquired "debt free", most parties will intend that all external debts (i.e. bank debts) be repaid upon completion. However, what about trading debts arising in the ordinary course of business? What about hire purchase and finance leasing agreements or intra company debts? Do these also constitute "debts" which should be discharged upon completion in order to achieve a "debt free/cash free" position?

A sensible starting point for the debate is to identify exactly what debt the target currently has, and more specifically the likely level of that debt at the point of proposed completion. "Debt free" can be achieved in a number of ways:

• the target repays the debt prior to completion (beware of financial assistance issues);

• the seller repays the debt prior to completion;

• the debt remains in the target company, with arrangements put in place to discharge the debt immediately following completion (beware of financial assistance issues); or

• the buyer assumes the debts but reduces the purchase price by an amount equal to the debt.

As regards the concept of a target being acquired "cash free", again a sensible starting point is to agree what is meant by "cash". Usually, the term cash free does not mean that the seller will be entitled to empty the target bank accounts immediately prior to completion. A more likely intention is that the seller will be permitted to remove any "spare" cash before the target is sold. "Cash free" can be achieved by using the "spare" cash in a number of ways including:

• repayments of indebtedness (which goes towards achieving "debt free");

• pre-completion dividend (subject to the target having sufficient distributable reserves);

• purchase of own shares (subject to the target having sufficient distributable reserves); and

• pension payments to individual sellers.

It is important to remember that the buyer's interpretation of "debt free/cash free" will almost certainly be made on the assumption that the target company will be left with adequate working capital. The buyer will normally expect that the target will be able to continue to trade for the foreseeable future immediately following completion. Again, it is vital that the parties discuss and agree what constitutes adequate working capital

from the outset.

Lupton Fawcett LLP can assist by advising on what is intended by "cash free/debt free" in any particular circumstances.

Small Company Valuation

Common Methods

Ultimately, the value of anything being sold is what someone is willing to pay for it. There are, however, many accepted methods for determining value when it comes to your business: Book Value, Discounted Cash Flow, Multiple of Cash Flow and Multiples of something else—for example, some industries are valued at a multiple of subscribers, a multiple of revenue, etc.

Hadley Capital's Approach to Valuation

Hadley Capital values Companies based on their ability generate sustainable, operating cash flows. We typically apply a multiple to the annual, sustainable operating cash flow of a business to estimate its value. We use EBITDA as a rough but good estimation of operating cash flow. To determine sustainable cash flow, we adjust EBITDA to include some positive and negative add backs.

Positive add backs that increase EBITDA may include:

• Owners excess compensation• Rental expense above market rates• Owners benefits that are not required to run the business such as automobiles,

vacations, etc.Add backs that may decrease EBITDA include:

• Rental expense below market value• Substantial annual capital expenditures• Additional salaries required when the owner departs

A Valuation Tool

EBITDA Multiples

Once sustainable EBITDA is determined, Hadley Capital applies a multiple of EBITDA to determine the Enterprise Value of your business. In general, smaller companies typically trade for between 3x to 5x normalized EBITDA. The difference in the multiple is generally the result of a variety of characteristics specific to your business, including:

• Sales growth rate• Gross Profit Margin• Annual EBITDA• EBITDA Margin• Annual capital expenditures• Working capital requirements• Customer concentrationValuation Tool

Try Our Business Valuation Calculator

The Structure of the Offer is Important

Comparing Offers

Not all offers are the same or comparable. Some buyers may offer a higher "headline number", that suggests your business is worth more, but contingency payments like earnouts, seller financing requirements and complicated financing structures may add risk to the offer by stretching out payments over time rather than a single, substantial check at closing.

Committed Capital

At Hadley Capital, we are private equity investors with capital on hand, which means that most of our transactions involve substantial cash at closing. We can structure payment using a variety of financing techniques but most sellers prefer cash even if our valuation appears slightly lower than a competing offer with complicated or protracted buyout contingencies. We are happy to discuss options and explain how price differences really work and how cash can pay added dividends.

Common Pitfalls

Enterprise Value vs. Equity Value

Hadley Capital's valuations are almost always based on an enterprise value, rather than an equity value, and are usually on a cash-free, debt-free basis. As the seller, you are responsible for satisfying (paying off) any existing debts. Equity Value is what is left after subtracting debt from Enterprise Value. Enterprise Value and Equity value may be most easily understood by comparing them to someone's home value. The Enterprise Value of a home is the total value of the home. The Equity Value of the house is the total value less the mortgage on the home. It's the same with your business; Equity Value is what's left after you pay off any debts.

Working Capital Adjustment

Working capital is the capital required to operate a business in a steady state environment. Hadley Capital acquisitions always include a working capital adjustment at closing. A working capital adjustment increases or decreases cash at closing based on the performance of the business between executing a LOI and closing a transaction. If the business grows between LOI and closing, the working capital adjustment will result in higher sale proceeds because the working capital grows. If working capital declines, the purchase price will be lower. The working capital adjustment is not meant to benefit the seller or the buyer but, rather, to compensate for balance sheet changes (to the positive or negative) between LOI and closing.

Inventory

Occasionally Hadley Capital will meet a seller that says "my business is for sale for $5 million plus the value of the inventory." It is not industry standard to value the two separately. Inventory is an asset of a business and is part of a company's Working capital and, thus, included in the Enterprise Value of a company.

Customer Deposits

In a cash-free, debt-free transaction, the seller of a business keeps the company's cash. Since customer deposits represent cash collected from customers for projects that are in process, it is standard practice to reduce sale proceeds by the amount of customer deposit liabilities because the buyer will need the deposits to complete projects in process. Since the seller gets to keep the cash associated with customer deposits, the result is a net zero impact on value.

Escrow

An escrow is a hold back of a certain amount of the cash at closing to cover representations and warranties made in a purchase agreement. The size and term of an escrow will vary depending upon the transaction, but typically are 10% to 15% of the transaction value and are typically in place for 12 to 24 months.

Earnouts

Earnouts can be an effective way to bridge a valuation gap between buyers and sellers. Earnout payments are made to a seller based on the future performance of the business and based on a pre-determined calculation. Since earnouts are a form of contingent purchase price, sellers need to weigh the risks of waiting for the value of the business to increase versus accepting an all-cash offer.

Seller Note

A Seller Note (sometimes called Seller Financing or Seller Debt) is a debt obligation issued by a seller of a business to a buyer and used by the buyer to finance a portion of the purchase price. Seller Notes are often subordinated to other debt issued to a buyer to complete a leveraged buyout. Seller Notes are typically structured as a

five year, interest bearing note. Amortization, or principal repayment, of a Seller Note, is usually over five years or as a lump sum or bullet payment at maturity.

Acquisition Process Guide

Step 1: Introductions

Direct Contact

Business owners often contact us directly to determine if we are interested in acquiring their company or partnering with them to invest in and help grow their business. To see if Hadley Capital might be a good fit for you, please see our Investment Focus section.

Intermediary

In other cases, intermediaries, including business brokers, investment bankers, commercial bankers, accountants, etc. introduce business owners to Hadley Capital. Frequently, the intermediary has been engaged by the business owner. Intermediaries can help owners reach a larger pool of buyers, guide owners through the sale process and assist owners in identifying qualified transaction advisors (such as attorneys). Hadley Capital has acquired companies where intermediaries were involved and those where they were not. Choosing an intermediary—or not—is a personal decision. We have established relationships with intermediaries from all over the country and would be happy to make introductions to them. Of the 1,000 or so companies we are introduced to each year, approximately 25% proceed to Step 2.

Step 2: Preliminary Review

Preliminary Review

Once we have determined that your business meets our investment criteria, and you have determined that Hadley Capital is a legitimate buyer, we typically exchange a Confidentiality Agreement, so you can share the following information with us:

• Summary of the needs of the business owner (outright sale, recapitalization or partial sale, management buyout, etc.)

• 3-5 years of financial results (P&L and balance sheet)• Review of annual Owners Benefits• Summary of top customers• Other information that is particularly relevant based on the type of business

(for example, annual capital expenditures in a capital-intensive business)

After reviewing this information and a follow-up telephone conversations, we will either confirm our interest and discuss next steps or politely decline.

If we move ahead, Hadley Capital will typically issue a term sheet and arrange an on-site visit.

Of the 1,000 or so companies that we are introduced to each year, approximately 10% proceed to Step 3.

Step 3: From Term Sheet to LOI

Post Visit

After a successful visit, the process becomes more involved and more formal. Additional information is exchanged, and another site visit may take place. As Hadley Capital continues to learn about your business, and you learn more about us, further discussions regarding company valuation and transaction structure occur. The term sheet from Step 2 may be revised multiple times during this stage and, eventually, lead to a formal Letter of Intent.

Letter of Intent

A Letter of Intent, or "LOI", is a formal, written document indicating the terms a buyer is offering a seller in a proposed acquisition or investment. An LOI states a serious intent, by both parties, to carry out the proposed transaction. Hadley Capital is very selective about issuing LOIs because they indicate that we will be dedicating substantial resources to acquiring your business under the terms outlined in the LOI.Less than 1% of the companies we review result in a Letter of Intent and proceed to Step 4.

Step 4: From Letter of Intent to Closing

Due Dilligence

Due diligence is a rigorous 30-day review of the business and includes a detailed analysis of accounting history and practices, operating practices, customer and supplier references, management references and market reviews. The due diligence process is managed by a Hadley Capital partner with the assistance of third party advisors such as accountants.

Financing

Hadley Capital has the committed capital required to complete acquisitions. But, in nearly all cases, we use some form of debt financing to supplement our equity capital. The debt financing process includes identifying lenders interested in partnering with Hadley Capital to complete the acquisition. Hadley Capital maintains a large Rolodex of lenders that we partner with to complete acquisitions.

Closing

The final step in the acquisition process is the legal documentation and funding step. Upon completion of the legal process, the acquisition funds are wired to the seller and the acquisition is complete. When the deal is finally done, we can celebrate the beginning of our mutually beneficial and profitable future together.

Enterprise Value

In this article, we will see how to calculate equity value and enterprise value.A few weeks back, a friend of mine bought a house. He was happy to share the news with all friends.He threw a big party and celebrated the purchase of this true asset. While discussing the cost of this asset, he explained the various costs attached to it.Actual acquisition cost of the house was 10% more than the list price.Why 10%?It included hidden costs like repairs to be done, unpaid bills, different obligations and various registration costs.But, my friend benefited from furniture which he got free with the house.Okay! You will ask me what this house story has got to do with the headline of this article, right?Now, imagine you are an equity research analyst and working on the valuation of a company to be acquired.Take the essence of the house story in this context and you will understand the difference between equity value and enterprise value clearly.

Equity Value vs Enterprise ValueEquity value will tell you what a company is worth and enterprise value tells you how much it would cost to acquire a company.So, in my house story, the list price is equity value, whereas, the addition of 10% to list price would give you enterprise value of that house.Enterprise value will take into account the debt part, obligations and the free things like cash that the company has.

Calculation of equity value and enterprise valueHow do you calculate equity

Valuation of Equity/ Equity Value formula= Common Shares Outstanding * Share Price

What is enterprise value?How to calculate enterprise value (EV)?Enterprise Value formula= Equity Value – Cash + Debt + Minority Interest + Preferred StockWhy subtract Cash?Remember the free furniture my friend got with his house purchase?That’s a gift and his cost of acquisition would be reduced by the furniture cost.How?Simple, he doesn’t have to invest money in buying new furniture and that will save him a lot of money.The same way, if you are acquiring a company having some cash (including short term and liquid marketable investments) on its balance sheet, you will pocket that cash and your acquisition cost will be reduced effectively by that amount.Why add Debt?If the company has debt (loans) on its balance sheet, you will have to pay that loan.You will have to pay the debts that include short/long term debts, revolvers, mezzanine and so on.Why do you add minority interest to enterprise value/Why add Minority Interest?When you own more than 50% of another company, the minority interest comes into the picture.It is the percentage that you don’t own.Why add Preferred Stock?Preferred stock is similar to debt which has fixed dividend.You will find Preferred Stock listed on the Liabilities side of the Balance Sheet.Concluding note:My friend is happy with the newly acquired house.As an analyst, your role is to see your clients happy with the acquisition of the companies.I hope, you are now clear with these two concepts: Equity Value and Enterprise Value.Have you bought any asset that explains these two concepts- Equity Value and Enterprise Value clearly? Share your experience here.

A tangled web of values: Enterprise value, Firm Value and Market CapInvestors, analysts and financial journalists use different measures of value to make their investment cases and it is not a surprise that these different value measures sometimes lead to confusion. For instance, at the peak of Apple's glory early last year, there were several articles making the point that Apple had become the most valuable company in history, using the market capitalization of the company to back the assertion. A few days ago, in a reflection of Apple's fall from grace,  an article in WSJ noted that Google had exceeded Apple's value, using enterprise value as the measure of value. What are these different measures of value for the same firm? Why do they differ and what do they measure? Which one is the best measure of value?

What are the different measures of value?To see the distinction between different measures of value, I find it useful to go back to a balance sheet format, with market values replacing accounting book values. Thus, the market value balance sheet of a company looks as follows:

Note that operating assets include not only fixed assets, but also any intangible assets (brand name, customer loyalty, patents etc.) as well as the net working capital needed to operate those assets and that debt is inclusive of all non-equity claims (including preferred equity).

Let's start with the market value of equity. Rearranging the financial balance sheet, the market value of equity measures the difference between the market value of all assets and the market value of debt.

The second measure of market value is firm value, the sum of the market value of equity and the market value of debt. Using the balance sheet format again, the market value of the firm measures the market's assessment of the values of all assets.

The third measure of market value nets out the market value of cash & other non-operating assets from firm value to arrive at enterprise value. With the balance sheet format, you can see that enterprise value should be equal to the market value of the operating assets of the company.

One of the features of enterprise value is that it is relatively immune (though not completely so) from purely financial transactions. A stock buyback funded with debt, a dividend paid for from an existing cash balance or a debt repayment from cash should leave enterprise value unchanged, unless the resulting shift in capital structure changes the cost of capital for operating assets, which, in turn, can change the estimated value of these assets.

The measurement questionsTo arrive at the market values of equity, firm and enterprise, you need updated "market" values for equity, debt and cash/non-operating assets. In practice, the only number that you can get on an updated (and current) basis for most companies is the market price of the traded shares. To get from that price to composite market values often requires assumptions and approximations, which sometimes are merited but can sometimes lead to systematic errors in value estimates.

I. Market value of equityWhile the conventional practice is to multiply the shares outstanding in the company by the share price to get to a market capitalization and to use this market capitalization as the market value of equity, there are three potential measurement issues that have to be confronted:• Non-traded shares: There are some publicly traded companies with multiple

classes of shares, with one or more of these classes being non-traded. Though these non-traded shares are often aggregated with the traded shares to arrive at share count and market cap, the differences in voting rights and dividend payout across share classes can make this a

dangerous assumption. If you assume that the non-traded share have higher voting rights, it is likely to you will understate the market value of equity by assigning the share price of the traded shares to them. 

• Management options : The market value of equity should include all equity claims on the company, not just its common shares. When there are management options outstanding, they have value, even if they are not traded, and that value should be added to the market capitalization of the traded shares to arrive at the market value of equity in the company. For a company like Cisco, this can make a significant difference in the estimated market value of equity (and in the ratios like PE that are computed based on that market value). Again, using short cuts (such as multiply the fully diluted number of shares by the share price to get to market capitalization) will give you shoddy estimates of market value of equity.

• Convertible securities : To the extent that a company raised funds from the use of bonds or preferred stock that are convertible into common equity, the conversion option should technically be treated as part of the value of equity (and not as debt or preferred stock). Failing to do so will understate the market value of equity in companies with lots of convertible securities outstanding.

II. DebtIn theory, the firm and enterprise values of a company should reflect the market value of all debt claims on the company. In practice, this is almost never the case for two reasons:• Non-traded debt: The problem of non-trading is far greater with debt than

equity, because bank debt is a large proportion of overall debt, even for many companies that issue bonds, and is the only source of debt for companies that don't issue bonds. Lacking a market value, many analysts have resorted to using book value of debt in their firm value and enterprise value computations. Though the effect of doing so is relatively small for healthy companies (book values of debt are close to market values of debt), it can be large for distressed companies, where the book value of debt will be far higher than the market value of that debt, leading to much higher estimates of enterprise and firm value for these firms than is merited.

• Off balance sheet debt : To the extent that firms use off-balance sheet debt, we will understate the firm and enterprise values for these firms. While this may sound like a problem only with esoteric firms that play financing games, it is actually far more prevalent, if you recognize lease commitments as debt. Most retailers and restaurant companies have substantial lease commitments that should be converted into debt for purposes of computing firm or enterprise value. 

III. Cash Cash should be simple to value, right? That is generally true but even with cash there are questions that analysts have to answer:

• Operating versus non-operating cash: To the extent that some or a large portion of the cash balance that you see at a company may be needed for its ongoing operations, you should be separating this portion of the cash from the overall cash balance and bringing into the operating asset column (under working capital). There are two problems we face in making this distinction between operating and excess cash. The first is that operating cash needs will be different across different businesses, with some businesses requiring little or no operating cash and others requiring more. The second is that cash needs have changed over time, with a shift away from cash based transactions in many markets and companies collectively require less cash than they used to a few decades ago. Analysts and investors, for the most part, have no stomach for making the distinction between operating and non-operating cash on a company-by-company basis and use one of two approximations. The first is to assume no operating cash and treat the entire cash balance as excess cash in computing enterprise value. The second is to use a rule of thumb to compute operating cash, such as setting cash at 2% of revenues for all firms. Again, while either approach may do little damage to value estimates at the typical firm, they will both fail at exceptional firms, where the cash balances are very large (as a proportion of value) but are untouchable because they are is needed for operations.

• Trapped cash : In the last decade, US companies with global operations have accumulated cash balances from their foreign operations that are trapped, because using the cash for investments in the US or for dividends/buybacks will trigger tax liabilities.  If a company has a very large cash balance and a significant portion of that cash is trapped, it is possible that the market attaches a discount to the stated value to reflect future tax payments. Netting out the entire cash balance to get to enterprise value will therefore give you too low an estimate of enterprise value, a point to ponder when netting out the $145 billion (with >$100 billion trapped) in cash to get to Apple's enterprise value.

IV. Other non-operating assetsWhen companies have non-cash assets that are non-operating, your problems start to multiply. With many family group companies, where cross holdings are the rule rather than the exception, the effect of miscalculating the value of non-operating assets can be dramatic.• Cross holdings in other companies:   When a company has non-controlling

stakes in other companies, the market value of these holdings should be netted out to get to the enterprise value of the parent company. Doing so may be straightforward if the cross holdings are in other publicly traded companies, where market prices are available, but it will be difficult if it is in a private business. In the latter case, the value of the cross holding on the balance sheet will, in most cases, reflect the book value of the investment,

with little information provided to estimate market value. The problems become worse if there are dozens of cross holdings, rather than just a handful. Not surprisingly, most analysts completely ignore cross holdings in computing enterprise value and the remaining net out the book value of the holdings. For companies that derive a large proportion of their value from cross holdings, this will lead to an upwardly biased estimate of enterprise value. When a company has a controlling or a majority stake in another company, a different kind of problem is created when computing enterprise value. The market value of equity in the parent company reflects only the majority stake in the subsidiary but the debt and cash in the computation are usually obtained from consolidated balance sheets, which reflect 100% of the subsidiary. To counter this inconsistency, analysts add the minority interest (which is the accountant's estimate of the equity in the non-owned portion of the subsidiary) to arrive at enterprise value, but the minority interest is a book value measure.

• Double counting of operating assets : One of the real dangers of fair value accounting and its push to bring more invisible or intangible assets to the balance sheet is that it increases the risk that analysts will double count. Thus, even if brand name and customer lists are valued and put on the balance sheet, they are very much part of the operations of the firm and should not be netted out as non-operating assets. Only assets that don't contribute (and are never expected to contribute) to operating income can be treated as non-operating assets.

Mismatches and Measurement ErrorsLooking at the standard practices in value estimation, there are two clear inconsistency problems that you see crop up. One is in the mixing of market values, estimated values and book values for different items in the computation. The other and related question is that the market values can be updated constantly but the book value based numbers are as of the last financial statement.

I. Market versus Book valueIn a typical enterprise value computation, the only number that comes from the market is the market capitalization, reflecting the market value of equity in common shares. The remaining numbers all come from accounting statements and reflect accounting estimates of value, with varying implications. With debt, as we noted, the difference between book and market value is likely to be small for healthy firms but much larger for distressed companies. With cash, the accounting estimates of value should be close, with the caveat that trapped cash may be discounted by the market to reflect expected tax liabilities. With cross holdings, the gap between book and market value can vary depending on how old the holding is (with older holdings have larger gaps) and the accounting for that holding.

While getting true market values for bank debt and cross holdings may be a pipe dream, there is no reason why we cannot estimate the market values for both. For debt, this will require using the interest expenses and average maturity on the debt to compute an estimated market value of the debt (akin to pricing a coupon bond). With cross holdings (minority holdings and interests), it may require us to use sector average price to book ratios to estimate the values of the cross holdings.

II. Timing DifferencesWhile you would like values to be current (since your investment decisions have to reflect current numbers), only market-based numbers can be updated on a continuous basis. The only market-based number in most enterprise value calculations is the market capitalization number (reflecting current stock prices), with the other numbers either directly coming out of accounting statements (debt, cash) or indirectly dependent on information in them (options outstanding, lease commitments). There are two questions, therefore, that you have to confront: (a) Should you try for timing consistency or current value? (b) If you go current value, what types of biases/problems will you face because of the timing mismatch?

• Consistency versus Current Values : If you are using the value estimates to look at how values change over time or why values have varied across companies in the past, consistency may win over updating. Thus, rather than using the current market value of equity, you may use the market value of equity as of date of the last financial statement. If you using the value estimates to make investment or transaction judgments today, the current value rule should win out. After all, if you find a company to be cheap, you get to buy it at today's price (and not the price as of the last financial statement). 

• Biases/Errors from Time mismatches : Assuming that the need to be updated wins out, your biggest concern with using dated estimates of debt, cash and other non-operating assets is that their values may have shifted significantly since the last reporting date. Not only can companies borrow new debt or repay old debt, which can affect the cash balance, but the operating needs of the company can lead to a decline or augmentation in the cash. For young growth companies, with large investment needs and/or operating losses, the cash balance today can be much lower than it was in the last financial statement. For mature companies in cashflow-rich businesses, cash balances can be much higher than in the last financial statement.

In fact, the mismatch can sometimes lead to strange results, especially for young, growth companies that have had operating/financial/legal problems in the very recent past. A drop in market capitalization combined with a cash balance from a recent financial statement that is much higher than the true cash balance can

combine to create negative enterprise values for some firms.

Financial service companiesThis discussion has been premised on two assumptions, that debt is a source of capital and that cash is a non-operating asset to businesses. There is a subset of the market where both assumptions break down and it is especially so with financial service companies, where debt is more raw material than source of capital and cash & marketable securities cannot be claimed by investors. With banks, investment banks and insurance companies, the only estimate of value that should carry weight is the market value of equity. You can compute the enterprise values for JP Morgan Chase and Citigroup but it will be an academic exercise that will yield absurdly high numbers but will provide little information to investors.

The NumbersTo illustrate the difference between the different measures of value, I first screened for global non-financial service companies with market capitalizations exceeding $25 billion and computed the firm and enterprise values for each of them. You can download the entire spreadsheet of 292 companies by clicking here. I then created a list of the top 20 companies by market capitalization and ranked them based upon the other measures of value as well.

Apple is more valuable than Google, if you use market capitalization as your measure of value, whereas Google is more valuable than Apple, if you use enterprise value, and GE dwarfs both companies, based upon enterprise value, because it has $415 billion in debt outstanding. Note that much of this debt is held by GE Capital and given my earlier point about debt, cash and enterprise value being meaningless in a financial service company, I would view GE's enterprise value with skepticism. Nothing in this table tells me which companies are good investments and which ones are over priced and all the caveats about mixing market and book value, timing differences and missing numbers apply.

Why have different measures of value?

Having multiple measures of value can create confusion, but there are two good reasons why you may see different measures of value and one bad one.

1. Transactional considerationsThe measure of value that you use can vary, depending on what you are planning to acquire as an investment. For instance, in acquisitions, where the acquiring firm is planning on acquiring the operating assets of the target firm, it is enterprise value that matters, since the acquiring firm will use its own mix of debt and equity to fund the acquisition and will not lay claim on the target company's cash. In contrast, if you are an individual investor in a publicly traded company, the market capitalization may be your best measure of value since you have little control over how much debt the company has or how much cash it holds. In fact, enterprise value based calculations can be misleading for individual investors, since they can mask default risk: a firm on the verge of default can look cheap on an EV basis.

2. Consistency in multiplesIn investing, we use estimates of market value to arrive at measures of relative value (multiples), so that we can compare how the market is pricing comparable companies. Relative value requires that the market value be scaled to a common variable (earnings, revenues, book value) and is governed by a simple consistency rule. The measure of value that we use in the numerator of a multiple should be consistent with the measure of earnings or book value that we use in the denominator. Equity values should be matched up to equity earnings or book equity and enterprise values to operating income or book capital. Consider, for instance, PE ratios and EV/EBITDA multiples. The PE ratio is obtained by dividing the market value of equity by the net income (or price per share by earnings per share); both the numerator and denominator are equity values. The EV/EBITDA is obtained by dividing the enterprise value (market value of operating assets) by the EBITDA (the cash flow generated by these operating assets). In the table below, I list the potential choices when it comes to consistent multiples:

3. Agenda-based value estimationIn some cases, the choice of value measure may depend upon the agenda or biases of the analyst in question. Thus, an analyst that is bullish on Apple will

latch on to its enterprise value to make his or her case, since it makes Apple look much cheaper.

Closing thoughtsWhen it comes to which value estimate is the best, I am an agnostic and I think each one carries information to investors. The PE ratio may be old fashioned but it still is a useful measure of value for individual investors in companies, and enterprise value has its appeal in other contexts. Understanding what each value measure is capturing and being consistent in how it is computed, compared and scaled is far more important than finding the one best measure of value