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Equity Value is used extensively in finance, especially in a merger or acquisition. Equity value is commonly used by owners and current shareholders in their decision-making process. In this article, we will explore different kinds of equity value as well as how equity value is used and calculated.
1. What is Equity Value?
Simply speaking, Equity Value is the total value of the company available to equity investors after any debts have been paid off. For example, if the company were to go bankrupt, the equity value would be the amount of money left to shareholders after it fulfills all debt obligations.
Why is equity value important to a business? Other than the bankruptcy scenarios shown above, net equity value is often used by banks to determine the financial health of a company. When underwriting a business loan, most banks will first analyze the equity value because it offers an analysis of how much the business is worth as collateral. Equity value is also important to minority buyers, when, say, they want to acquire a minority interest in a company.
Option 1 (Direct method):
Equity value = Share price x Number of shares outstanding
Option 2 (Indirect method):
Equity value = Enterprise value – Debt and debt equivalents – Non-controlling interest – preferred stock + Cash and cash equivalents.
Under the direct method, equity value is calculated by multiplying the value of each share of the company by the total number of shares outstanding. This method is often used as a quick and fast way to calculate the market value of equity, or, in other words, the market capitalization of a company.
Under the indirect method, equity value is calculated through the enterprise value. The calculation for equity value adds enterprise value to non-operating assets and subtracts the net debt. This method is often employed to come up with the intrinsic value of equity, used to accompany the valuation process.
3. Market, Intrinsic, and Book Value of Equity
Market value of equity is calculated by multiplying the market value of each of its shares by the total number of outstanding shares. On the other hand, the book value of equity is the difference between a company’s assets and liabilities. For healthy companies, the market equity value often far exceeds the book value as the market share price appreciates over time.
The intrinsic value of equity is different from the market value. It is a measure of what a stock is worth. This measure is arrived at by complex valuation techniques rather than using the currently trading market price of that asset.
| Market value | Book value | Intrinsic value | |
|---|---|---|---|
| Definition | The equity value if sold to the market at the currently trading price | The common equity – the amount available that can be distributed among the shareholders | The true value of equity as calculated from fundamental and technical analysis by financial analysts |
| Calculation | Market value per share x number of shares outstanding | Total assets – total liabilities | Valuation models |
| Real-life uses | Used to measure a company’s size and helps investors diversify their investments across companies of different sizes and different levels of risk. | Good companies are those that have a book value that is lower than the market value | Used to determine the real price tag for the company’s shares |
4. Basic Equity Value and Diluted Equity Value
The basic number of shares is simply the current number of shares available on the secondary market, whereas the diluted number of shares is all the basic shares plus diluting securities such as convertibles (warrants, options, preferred stocks, etc.).
Basic equity value is calculated by multiplying a company’s share price by the number of basic shares outstanding. On the other hand, diluted equity value is calculated by multiplying the share price by the number of diluted shares outstanding.
It is often more accurate to use diluted shares outstanding when calculating the equity value or enterprise value as it more accurately reflects the cost of acquiring a firm.
5. Equity Value and Enterprise Value
Both equity value and enterprise value are important concepts you will encounter in any finance interview. It is really important to understand the difference between equity and enterprise value.
When a company is bought, the purchase agreement in-the-money dilutive securities get cashed out or get converted into an equivalent number of the buyer’s securities. Either of those scenarios would cost the buyer something when it acquires the company in question. Equity value is like the sticker price saying how much it costs to buy the company. However, there are additional items that can push up or push down the effective price afterwards, so the actual cost of buying that company might be different from the sticker price. This actual price is the enterprise value.
Enterprise value = Equity value + Debt and debt equivalents + Preferred Stock + Non-controlling interest – Cash and cash equivalents
Equity value = Enterprise value – Debt and debt equivalents – Non-controlling interest – Preferred stock + Cash and cash equivalents
Conclusion: Equity value is an important concept in finance and in finance technical interviews. It is important to not only understand the concept but also how it is calculated using both direct and indirect methods. We hope you’ve had a firm grasp of equity value by now.
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