The number everyone quotes measures one thing#
Market capitalisation is share price times shares outstanding. Ten million shares at $50 gives you a $500 million market cap. It’s fast, it’s public, and it’s the basis for how index funds like the S&P 500 weight their holdings — bigger companies, bigger influence.
What it measures is the market’s valuation of the equity. Not the business. The equity.
That distinction sounds academic until you buy something.
Enterprise value: what the thing actually costs#
Enterprise value is market cap plus total debt minus cash. The logic is an acquirer’s logic — buy the company and you inherit its debts and you get its cash.
Run two companies with identical $500M market caps:
| Company A | Company B | |
|---|---|---|
| Market cap | $500M | $500M |
| Total debt | $200M | $0 |
| Cash | $50M | $100M |
| Enterprise value | $650M | $400M |
Identical price tags, and A costs 63% more than B to actually acquire. Buy A and you’re writing a cheque for the shares and taking on $200M of obligations, offset by only $50M of cash. Buy B and $100M of the purchase price comes straight back to you the moment the deal closes.
Same sticker. Different bill.
Reading the gap#
The relationship between EV and market cap is itself a signal, and it’s a fast one.
EV above market cap means net debt. The company owes more than it holds. Not automatically bad — debt funds growth, and cheap debt used well is how businesses scale — but it means an acquirer, or you as a shareholder, sit behind lenders in the queue.
EV below market cap means net cash. The company holds more cash than debt, which buys flexibility: acquisitions, buybacks, or simply surviving a bad two years without asking anyone’s permission.
Neither reading is a verdict on its own. Heavy debt could mean a company aggressively funding expansion, or a company in trouble. A large cash pile could mean prudence or a management team with no idea what to do next. The gap tells you where to look, not what to conclude.
Why professionals default to EV#
The preference isn’t snobbery. Enterprise value is capital-structure neutral, which means it lets you compare two companies that financed themselves differently without the financing distorting the comparison.
That’s why M&A runs on it. Deals get negotiated in enterprise value terms — “5x EBITDA EV” — because the buyer is purchasing the whole capital structure, not a slice of equity. Analysts use EV precisely because market cap can’t tell you what a takeover costs.
Two multiples do most of the work:
EV/EBITDA compares enterprise value to earnings before interest, taxes, depreciation and amortisation. Lower suggests you’re paying less per dollar of operating earnings. It’s the standard multiple in M&A analysis and more useful than P/E when comparing companies with different debt loads — because P/E’s denominator is already distorted by interest expense.
EV/Revenue shows what you pay per dollar of sales. It’s the tool for unprofitable growth companies where EBITDA is negative and P/E is meaningless. Its weakness is that it ignores margins entirely: a dollar of software revenue and a dollar of grocery revenue are not the same asset.
Where this goes wrong#
Three traps worth naming.
Lower isn’t automatically cheaper. A low EV/EBITDA often means the market expects earnings to fall. The multiple is low because the E is about to shrink. Screening for the lowest number in a sector is a reliable way to find businesses in decline.
EBITDA isn’t cash flow. It excludes interest, tax, depreciation and amortisation — some of which are very real bills. Charlie Munger’s objection was that depreciation represents equipment that genuinely wears out and genuinely has to be replaced.
EV/Revenue flatters anything with a story. No margin, no profit, no problem — just a multiple of sales. Use it where you must, and never alone.
Summary — and what to do about it#
Market cap answers “what’s the equity worth?” Enterprise value answers “what does this business cost?” Only one of those is the question you’re asking when you buy a stock.
- Calculate EV before you judge any valuation. Market cap + total debt − cash. Both inputs are in the balance sheet.
- Compare EV to market cap as a quick health read. EV higher means net debt; EV lower means net cash.
- Use EV/EBITDA to compare companies with different debt loads. That’s the situation where P/E misleads most.
- Reach for EV/Revenue only when profits don’t exist yet, and pair it with a margin figure so you know what the revenue is worth.
- Treat an unusually low multiple as a question, not a discount. The market usually has a reason.
- Never use one ratio alone. Numbers point at where to investigate; the story behind the debt or the cash is what you’re actually assessing.
The habit is small and it changes what you see. Two identical price tags, two very different purchases — and only one of the two numbers ever appears in a headline.
Sources & further reading#
- Winvesta, “EV/EBITDA: The professional’s valuation metric” — capital-structure neutrality and why M&A negotiates on EV.
- Nasdaq, “Why Enterprise Value Can Be a Better Gauge Than Market Cap” — the acquisition-cost framing.
- Eqvista, “Enterprise Value-to-EBITDA” — when EV/EBITDA beats P/E.
- Wall Street Mastermind, “EV/EBITDA, EV/Revenue, and P/E explained” — how the three multiples differ in use.
