Enterprise value stands as being among one of the most widely used measures to valuing the monetary worth of any business.
In today’s dynamic and fast-paced world, this fundamental metric stands as being highly crucial, as a reliable valuation tool.
Because of its broad applications, and usefulness, it is a favored tool by investors, analysts, finance executives, as well as acquiring firms, all looking to reliably value a given entity, and aid financial decision-making.
In this article, we explore this solid financial measurement, delving into its strengths and application, examining its calculations, and understanding its sheer importance.
We also investigate it in relation to the candle chart context, in order to gain a more holistic view.
If you are looking to find out what exactly enterprise value is, and why it is so prized as a valuation metric across the financial markets in the world, look no further.
In this article, we shed light on this specific domain in a comprehensive manner.
What is Enterprise Value?
Enterprise value (EV) is a common financial measurement that calculates the value of a company.
It is distinct, and more comprehensive than market capitalization, as it factors in a lot more information, such as the liquidity position, and short and long-term debt.
Unlike the standard market capitalization, EV incorporates the value of both classes of financing: debt and equity.
It, therefore, emphasizes the notion that debt providers, along with shareholders, also have a rightful claim on the company’s assets.
Many in the financial markets favor EV as the superior valuation metric, due to its ability to provide a complete picture of an enterprise.
It is used as the basis of core investment decisions such as corporate acquisitions, spin-offs, and internal assessments.
Why is Enterprise Value important?
Here are a few reasons that make EV such a fundamental tool in finance:
It is an extremely comprehensive valuation metric
EV stands as being among one of the most complete and holistic measurements of value. It incorporates both the debt and equity sides of an enterprise, thus painting a reliable picture to turn to.
It provides a strong basis for comparison
Using the EV metric, analysts and investors can compare the values of different companies, which can assist in investment decisions.
Assists financial management with internal decisions
By turning to EV, management personnel from the finance departments can determine which debt levels, capital allocation, and other financial matters would result in the highest valuation for the enterprise.
It is also used to track improvements on a historical basis.
How to Calculate Enterprise Value?
To calculate enterprise value, we use the following formula:
Let’s break this down to gain a clearer understanding of how exactly this calculation works. We look at all the elements that tie into the EV, which are as follows:
This is what the market values the company based on individual share prices, and represents the equity side of the enterprise.
Market capitalization is derived by multiplying the share price by the number of outstanding shares.
The total debt is another fundamental portion of the total value of an enterprise, just as equity is, so it too is added to the equation.
It includes all classes of debt, short and long-term, along with every other payable and obligation.
Cash and equivalents
Cash and its equivalents are seen as free assets that can typically be used to pay off debt. Therefore, they do not add to the EV of a company and are hence subtracted from the equation.
How to Interpret Enterprise Value
The enterprise value tells us a lot more about the company than other metrics generally would. In particular, the EV can shed light on the following domains:
The EV points out the balance between a company’s debt and equity financing, and whether or not this balance is sustainable.
A company with extraordinary levels of debt and low equity would be generally seen as carrying high risk.
When EV is used for peer analysis, it can highlight how financially healthy a company is in relation to other players in the same industry. This, therefore, reveals the relative financial strength of a company.
EV can also be interpreted in light of a company’s financial performance metric. An extraordinarily high EV against poor financial performance could indicate serious overvaluation.
Alternatively, a low EV despite excellent performance could point out a potential undervaluation.
Managers often interpret EV in relation to the broader market and economic trends to assess how fairly the company’s value stands.
High EV during periods of low-interest rates is seen as a positive indicator, whereas low EV during a high-interest environment can be a potential red flag.
4 Benefits of using Enterprise Value for Business Analysis
Because enterprise value is such a sound measure of value, it comes as no surprise that it is a go-to financial tool in the domain of business analysis. Listed below are 4 benefits of using EV for business analysis.
Determining the financial strength of investment decisions
Through the use of EV, one can determine the soundness of a business’ investment decisions.
Often companies park their funds in various stocks, and through EV it can determine if shareholder value is being maximized in these financial decisions.
Guides merger and acquisition decisions
For larger companies, EV provides essential insight during mergers and acquisitions.
Determining the value of target companies through a comprehensive measure such as EV is a solid means of analyzing its business as a whole.
Evaluating risk management
Business analysis is incomplete without evaluating risk management, and EV provides clear answers to this regard.
EV can point out a disproportionate overreliance on debt financing, which severely enhances the risk of bankruptcy.
Predicts future performance
When used in business analysis, EV is a great way to predict the future earnings of a company.
This is when trends of EV multiples and EBITDA are studied over time to determine a benchmark standard, allowing reliable, value-based projections.
What is a Candle Chart Stock?
A candle chart stock is a way a stock’s price movement is graphically represented through a series of bars.
This is done in a manner to point out specific time periods such as hours or days and helps inform traders about patterns and price trends.
Each bar represented on the candlestick chart represents four crucial data points:
- High price
- Low price
- Opening price
- Closing price
Together, these data points come together in one bar as represented in the following example of a hypothetical candle chart stock:
As can be seen above, the shape of the price movement appears similar to a candlestick, with a body and two wicks on both ends of the candle.
8 Types of Candlestick Trading Patterns
The following are the eight most common trading patterns observed in candlestick charts:
- Hammer: When a candlestick shows a bullish bar with a small body, and a long lower wick, because of a significantly low-price gain achieved. Due to uncertainty, this stock rallies towards the end to close near its opening price.
- Inverted hammer: A small body with a long upper wick, showing significant high points achieved. Despite this, the gain remains limited as the stock price closes only slightly above its opening price.
- Shooting star: A candlestick showing a bearish reversal that looks similar to an inverted hammer. The crucial difference is that the stock closes below its opening price, delivering a loss for the day.
- Morning star: A pattern showing a bullish reversal with three candles. The first is long bearish, the second is small indecision, and the third is long bullish.
- Evening star: The inverse of a morning star, showing a bearish reversal in three candles: long bullish, small indecision, and finally long bearish.
- Hanging man: A bearish reversal candle that forms near the top of an uptrend. It indicates the end of a bullish trend and the beginning of a bearish one.
- Engulfing: A small bearish or bullish candle that is subsequently engulfed by a much larger candle of the opposite nature, indicating an imminent reversal.
- Doji: A candle stick with very long wicks on either side and an extremely small body due to the stock opening and closing very close to each other. This happens when there is high uncertainty in the market.
How to read the candle chart?
A candle chart, especially when part of a wider pattern, delivers a lot of information about price movements. Accessing this valuable insight requires one to know how to read the candle chart.
To be able to read a candle chart, traders must be aware of the various types of candlestick patterns and technical indicators that relate to such charts.
The following basic elements are crucial to understand, for one to gain useful insight through a candle chart:
The body is the distance between the opening and closing prices of a stock, during a particular time frame. The longer the body, the higher the movement in price during that time.
When the closing price is higher than the opening, the body is usually green, otherwise, it is represented as red.
Throughout the trade period, the security price moves to highs and lows.
The highest price point achieved during the period is shown through the high end of the wick, whereas the lowest point is shown by the low end of the wick.
Every candle in the chart represents a specific time frame which could range from 15 minutes, an hour, or even a full 24-hour period.
When a series of candles are assessed as part of a wider pattern they point out a trend that is very insightful about the broader price movements, and whether they are bearish, bullish or in a state of uncertainty.
Using EV to Interpret Candle Chart Patterns
Retail traders are typically more interested in technical indicators to interpret candle chart patterns, rather than valuation metrics.
However, many turn to the enterprise value when looking to carry out a broader fundamental assessment of the stock they are monitoring.
Because candle chart patterns deal with bearish and bullish movements, traders are usually interested in whether the stock is under or overvalued. This can be done by assessing a stock based on its EV multiples.
This helps predict if a price correction is imminent.
EV sheds light on a specific aspect of a company’s valuation, and traders can turn to a broader set of tools for a more informed decision.
Ultimately, the use of EV would depend upon the specific approach and trade strategy followed by the trader.
Understanding Market Sentiment with Enterprise Value and Candle Charts
EV and candle charts both shed light on different dimensions of the market. When brought together, however, they can be used to assess wider market sentiment.
In times of market optimism, the enterprise value would generally be higher, despite low earnings, which could suggest wider bullish sentiment.
Alternatively, when EV is consistently low despite high earnings, it is evident that market sentiment is overwhelmingly bearish.
Similarly, patterns from a candlestick chart could be used to enhance the findings from EV on market sentiment. These patterns could reveal through buying and selling behavior the general mood of the overall market.
Making Informed Business Decisions with Enterprise Value and Candle Charts
Both EV and Candle Charts emphasize the notion that, although different metrics provide different perspectives on a company’s financial health, they can be brought together to enhance overall decision-making.
While enterprise value explores the fundamentals of a company’s value in its financial structure, and the candle chart reveals short-term trading patterns, they complement each other and help outline sentiment while predicting future movements and performance.
Where the EV focuses on long-term fundamentals, candle charts look into short-term movements. Together, both tools hold important roles in stock analysis and are critical measures that guide decision-making.
Enterprise value is a powerful tool that allows market participants to value companies. Unlike similar metrics like market capitalization, it factors in debt financing to give a more holistic take on determining the value of a company.
The use of EV significantly aids decision-making by exploring the financing structure of a particular enterprise, and hence the overall financial sustainability. The metric is especially useful in guiding investment decisions.
When used alongside tools like the candle chart, EV sheds light on areas such as market sentiment and allows analysts and investors to predict financial performance.
EV empowers its users by delivering a deeper understanding of a company’s financials.
How do you draw candle charts?
A candle chart is drawn by plotting a stock’s opening price, closing price, and highest and lowest points in a specific time frame.
The opening and closing prices will determine the length of the body, whereas wick lengths will show the highest and lowest price points.
Which candle type is best for trading?
The best candle type will differ with each trading strategy and state of the wider market.
Traders will typically be most successful when they are able to soundly interpret the pattern, while tying their analysis to a broader metric, like the enterprise value.
What is enterprise value vs market value?
Enterprise value tells us the value of a company’s total equity and debt financing, whereas market value focuses predominantly on the equity side of the enterprise.