Equity ValueDefined along with Formula & How to Calculate

Written By:
Lisa Borga

Equity value, which is also referred to as market capitalization, is the value of a company that is available to its equity investors.

This is an important figure for business owners and investors as it provides an indication of the value of a company where it is to be sold while accounting for potential growth.

This figure is often used alongside enterprise value to offer an accurate calculation of a business’s value.

Calculating Equity Value

In order to calculate equity value, all outstanding shares are multiplied by the share price of the company.

The formula for this is:

Equity Value = Total Shares Outstanding * Current Share Price

This can also be calculated from enterprise value which is another measure of a company’s worth.

The formula for this is:

Equity Value = Enterprise Value – Preferred Shares – Minority Interest – Outstanding Debt + Cash + Cash Equivalents

In order to calculate market capitalization from enterprise value, all debt and debt equivalents, preferred stock, and non-controlling interests will be subtracted from enterprise value as these represent value in the company which belongs to others.

All cash along with any cash equivalents will be added to the resulting number, and any remaining value will represent the value in the company which is available to its equity shareholders.

The Difference Between Book Value and Market Value of Equity

A company’s book value is often far different and more complex to calculate than its market value.

A company’s market value is calculated simply by multiplying the price of its shares by the number of outstanding shares.

In contrast, the book value of a company provides a view of shareholders’ equity and refers to the value of a company according to its financial accounts.

This latter valuation allows shareholders to roughly see what they would receive if the company were to be liquidated.

For most companies, equity value will greatly exceed book value because it is generally assumed by most investors that a company’s earning power is greater than the value of its assets.

Another difference between these two valuations is that book value can be negative as a company’s liabilities exceed the value of its assets.

However, market value can never be negative, as both the share price and the number of outstanding shares can never drop below zero.

Basic vs. Diluted Equity Value

Generally Accepted Accounting Principles (GAAP) require companies to measure their per-share earnings using two methods of valuation, three including basic and diluted share value.

Basic equity value is found simply by taking the share price of a company and multiplying it by the number of outstanding shares, and this value can be found easily on the company’s 10K report.

However, this valuation does not account for the effect on the value that could occur if all convertible securities were exercised.

Companies will often issue a wide variety of convertible securities, which can greatly dilute the value of basic shares, and if a company were to be sold, the buyer would be required to pay for these securities, which is why these shares should always be included when calculating equity value.

In addition to reducing the value of per-share equity for shareholders, this also raises the acquisition cost for potential buyers; thus, diluted shares can have a significant impact on the ability to sell a company as well as the resulting earnings for shareholders.

These diluted shares can include a wide range of convertible securities, including stock options, convertible bonds, and more.

In order to account for the value of diluted shares, the number of shares that could be created for outstanding dilutive securities should be added to the number of basic shares outstanding.

The Difference Between Equity and Enterprise Value

There is a difference between enterprise value and equity value, and it’s important to understand it.

Equity value is the part of a company’s value that is available to equity investors.

In contrast, the enterprise value is a measure of the total value of a company.

Enterprise value can be calculated by using the equity value.

Just take the equity value and subtract cash along with cash equivalents.

Then, add preferred stock, minority interest, and debt.

Cash equivalents and cash are not part of enterprise value because they are not actually invested in the company.

Therefore, they are not part of the core assets of the company.

Generally, long-term and short-term investments also get subtracted.

But this is not always the case and needs to be determined by an analyst.

It will depend on the liquidity of the securities.

The reason minority interest, debt, and preferred stock are added back to enterprise value is that they are all amounts that are owed to other groups of investors.

Therefore, because enterprise value, unlike equity value, is available to all stockholders, these amounts need to be included.

Enterprise Value

Equity value can also be computed using enterprise value.

In order to do this, minority interests, preferred stock, as well as debt, and debt-equivalents must be subtracted from the enterprise value.

Using Equity Value and Enterprise Value to Value Companies

Enterprise value, as well as equity value, can be used for valuing companies.

Although, there are some industries, including insurance and banking, in which only equity value can be used.

It is essential to know whether to use enterprise value or equity value when determining the value of a company, and this will be determined by the metric that will be used to value the company.

When the metric uses interest income, expense, and net change in debt, then it will be necessary to use equity value.

However, if these items are not included, then enterprise value will be used.

The reason for this is that enterprise value is available to debt shareholders as well as equity shareholders.

Discounting the Cash Flows

When the equity value is being computed, the unlevered free cash flows, which are the cash flows that are available to equity stockholders, need to be discounted by equity’s cost.

This needs to be done because, in this calculation, we only want the amount that remains for equity investors.

However, when enterprise values are being calculated, the unlevered free cash flows, which is the cash flow that is available to equity shareholders, will be reduced by the weighted average cost of capital because this measure now accounts for what is actually available to a company’s investors.

Common Uses for Equity Value

One of the largest uses for equity value is for computing the price-earnings ratio.

This is the ratio most likely to be understood by everyday investors, but it’s not the one most preferred by financial professionals.

This is because the P/E ratio is affected by capital structure.

It can be influenced by non-recurring and non-cash charges as well as different tax rates.

But, there are some industries in which the P/E ratio and equity value may be preferred because they are more useful than the enterprise value and other valuation multiples.

Some of these industries are insurance firms, banks, and financial institutions.

The reason that the price-earnings ratio can be more useful for financial institutions than enterprise value and other valuation multiples is that these institutions use debt in a different way than other businesses.

For financial institutions, interest can be a significant part of revenue.

Additionally, it can be difficult to distinguish the financing activities of financial institutions from their operating activities.

It’s common for financial institutions to be valued by employing metrics including price/book value or price/earnings ratio.

Other Methods of Determining the Value of a Company

To determine the intrinsic value of a company, dividend discount models can be used.

In this model, the intrinsic value of a company is based on the sum of the net present value of the expected dividends.  

In some cases, a future share price valuation can be used.

To do this, the share price of a company is projected based on the price-earnings ratio of similar companies.

This number is then discounted to its present value.