In an earlier post, we began a discussion of the differences between two total capital valuation concepts, market value of total capital (MVTC) and enterprise value.  In this post, we will add to the discussion.

It is important to understand key balance sheet and market value concepts as well as how they relate to each other.  Appraisers and market participants examine market evidence for publicly traded companies to infer valuation metrics for private companies.  In valuation-speak, this method is called the guideline public company method.  A number of market multiples are commonly examined using the guideline public company method.

Equity and Total Capital Valuation Measures

There are a number of potential p/e multiples.  The most common p/e multiple compares the current market price to the trailing 12-months EPS.  However, p/e multiples can also be calculated based on expected current year earnings (if partially into a fiscal year), or to next year’s anticipated EPS.

A company’s market value of equity is the product of its current price per share and its number of shares outstanding.  This is a basic concept.  Appraisers also look at total capital concepts of value, which include debt and may or may not exclude cash.  Explicit consideration of cash in the guideline public company method can be important to obtain realistic value indications for subject private businesses.

Earnings multiples are calculated by appraisers based on total capital measures.  These measures may relate to sales, EBITDA (earnings before interest, taxes, depreciation and amortization), or EBIT (earnings before interest and taxes).

We have just discussed market value of equity.  Consider these four additional relationships:

• Market Value of Total Capital (MVTC). MVTC includes the market value of equity plus the market value of debt (usually considered at book value). MVTC would include any cash on the balance sheet of a public company to infer a valuation for a private company. For purposes of this discussion, assume that there are no other non-operating assets on either our guideline public companies or for a private company being valued.
• Enterprise Value. Enterprise Value is MVTC, as defined above, less cash. Enterprise value is also referred to as invested capital. The thought is that any cash on the balance sheet of a public company (or private company) is not actually invested in the company yet; rather it is sitting in a brokerage account or otherwise invested on a short-term basis awaiting distribution or actual investment into the enterprise.
• Market Value of Equity (Operating). The market value of equity on an operating basis is Enterprise Value less debt. MVE (Operating) represents the value of equity of a business before considering cash and any other non-operating or excess assets.
• Total Value of Equity. The Total Value of Equity for a business is the sum of MVE (Operating) and cash. The total value of equity is the equivalent of the market value of equity for a public company as noted above.

The difference between these total capital and equity value concepts is the treatment of cash. In the current market environment, many public companies have accumulated significant, even massive, amounts of cash. The treatment of cash, then, will impact multiples.

We focus first on the relationships in this post. In a subsequent post, we will examine the potential impact in the consideration of cash on calculated market multiples for public companies and the impact that treatment of cash can have on valuation inferences.

The Relationships in a Picture

The beginning point for valuation is the balance sheet on an historical cost basis. Depending on the history of a company’s operations, it may or may not have goodwill or other intangible assets on its balance sheet. Nevertheless, a company’s market capitalization may reflect substantial (or little) goodwill. So we begin with a conceptual balance sheet at the left side of the following diagram.