By: Esmat Hanano, Spring 2019 Student Intern
As economic markets continue to fluctuate, many companies are seeing their stock price move with market changes. Companies, however, are not the only ones watching—retail investors are also noting the changes. Shifting economic markets lead to some important questions about how to value a company given the current state of the economy, chief among them being which valuation metric should retail investors look to when making their investment decisions. To that end, there are two terms retail investors should be familiar with: enterprise value and market capitalization.
Market Capitalization is simply the total value of all available shares of a company. It is calculated by multiplying the number of outstanding shares by the share price. For example, a company with 10 million outstanding shares selling at $30 a share would have a market capitalization of $300 million. Market capitalization is split into three main categories: large cap, mid cap, and small cap. Large cap companies have a market capitalization of $10 billion or more, and mid cap companies have a capitalization between $1 billion and $10 billion. Small cap companies have a market capitalization of under $1 billion.
Enterprise value is a slightly more complicated metric for determining the value of a company. Enterprise value is calculated by adding the market capitalization and market value of debt the company owes, and then subtracting cash reserves and other assets the company has from that total. Although market capitalization can offer a quick snapshot of the value of a company, the company’s enterprise value gives a clearer picture of what exactly it’s worth.
For example, Amazon’s market capitalization as of January 16, 2019, is $820.75 billion. Its enterprise value is $819.64 billion. This difference might not seem like much when dealing with a company as large as Amazon, but the difference in which metric is used to determine the value of a company can be critical in certain circumstances.
Retail investors should always look to multiple sources of information when making investment decisions. An investor who understands concepts like market capitalization and enterprise value will be able to make better-informed decisions that can lead to sound investments.