How Savvy Investors Use Enterprise Value to Spot Better Deals

When you’re evaluating whether a company is truly undervalued, the stock price alone doesn’t tell the full story. This is where enterprise value steps in—a metric that gives you a much clearer picture of what you’re actually paying for a business.

Think of it this way: if you bought a used car for $10,000 but found $2,000 cash tucked in the trunk, your real cost drops to $8,000. The same logic applies to buying a company. The enterprise value represents the true acquisition price by accounting for both what you’re paying and what liquid assets offset that cost.

The Math Behind Enterprise Value

The formula is straightforward:

Enterprise Value = Market Capitalization + Total Debt − Cash

To calculate it, start with market cap (shares outstanding × current stock price), add all short-term and long-term debt from the balance sheet, then subtract the company’s liquid cash reserves.

Why subtract cash? Because a buyer could use those liquid funds to help pay for the acquisition, reducing the actual cost. Conversely, debt gets added because whoever buys the company inherits the obligation to repay it. This is fundamentally different from book value, which simply subtracts total liabilities from total assets without considering market sentiment.

Why This Metric Matters More Than You Think

Enterprise value is particularly powerful when combined with other financial metrics. Consider the price-to-sales (P/S) ratio—it divides market cap by revenue. But if you substitute enterprise value instead, you get EV/Sales (EV/S), which paints a more complete picture by factoring in debt and cash.

The same principle applies to profitability measures. EV/EBITDA (enterprise value divided by earnings before interest, taxes, depreciation, and amortization) provides deeper insight than traditional earnings multiples because it removes the noise of capital structure and accounting choices. Similarly, EV/EBIT excludes depreciation and amortization effects.

Calculating EBITDA is simple:

EBITDA = Operating Earnings + Interest + Taxes + Depreciation + Amortization

A Real-World Scenario

Let’s say a company has a market cap of $10 billion, carries $5 billion in debt, and holds $1 billion in cash. The enterprise value comes to $14 billion.

Now suppose this company generated $750 million in EBITDA. Dividing $14 billion by $750 million gives you an EV/EBITDA multiple of 18.6x. Whether that’s attractive depends entirely on the industry. A software company trading at 18.6x EBITDA might be a steal, while the same multiple for a retail business would signal overvaluation.

The Trade-Offs of This Approach

The advantages are clear: enterprise value gives investors a more holistic view of financial health and helps identify mispricings across different industries and capital structures.

But there’s a catch. The metric includes debt without explaining how well the company manages it or deploys it effectively. This becomes especially problematic in capital-intensive sectors like manufacturing or oil and gas, where high debt levels are necessary just to operate. Using enterprise value in these industries can skew your analysis and cause you to misjudge whether a company is truly expensive or cheap.

The Smart Way to Use This Metric

The best practice is always to compare a company’s enterprise value multiples against industry averages. A manufacturing firm with an EV/EBITDA of 12x might be reasonable if the industry average is 11x, but it would look expensive compared to a tech company with identical multiples. Context is everything.

By understanding enterprise value and applying it thoughtfully alongside industry benchmarks, you can move beyond surface-level price metrics and make more informed investment decisions. The additional layers of information—debt obligations and liquid reserves—make it one of the most useful tools in an investor’s toolkit.