A Tale of Two Total Stock Values: Enterprise Value vs. Market Cap

This article was updated on Dec. 10, 2014.

Market capitalization isn't the only way to measure the size of a stock. Enterprise value is in many ways a more fair measure, as it accounts for game-changing cash reserves and debt loads. But this metric gets far less attention than the simple market cap.

Let's change that.

The market cap is a simple calculation. Find a recent share price, multiply that by the total number of shares outstanding, and Bob's your uncle. The two data points you need are easily found, the math is trivial, and the resulting figure is easy to understand. It's no wonder so many investors never look beyond the simple market cap.

But the cap is just a starting point for enterprise value calculations. The enterprise value is the market cap, minus cash on hand, plus debt balances. Debt makes the value go up, while extra cash brings enterprise value down.

If that seems backward, think of the stock as a wallet for sale with either cash or IOU stubs tucked inside. Buying a wallet with free cash included works out to a discount for you, and vice versa; buying up a pocketbook full of debt papers that you have to take responsibility for could get expensive in a hurry. The enterprise value is what a hypothetical buyer would pay for the entire company, cash reserves and debt included.

Some stocks come with large market caps but smaller enterprise values due to their positive net cash balances. Many others turn that equation upside-down. Let's find some examples of each among the largest stocks in the S&P 500 (SNPINDEX: ^GSPC  ) market index:

Company Market Cap Enterprise Value EV/Market Cap Ratio
General Electric (NYSE: GE  ) $262 billion $628 billion 2.4

AT&T (NYSE: T  )

$176 billion

$250 billion

1.4

Facebook (NASDAQ: FB  )

$210 billion

$195 billion

0.9

QUALCOMM (NASDAQ: QCOM  )

$123 billion

$106 billion

0.9

Source: Yahoo Finance. Figures current as of Dec. 4, 2014.

These stocks show some of the largest imbalances between market cap and enterprise value. I'm not counting the financial powerhouses, because their capital-intensive business models don't lend themselves to enterprise value discussions. The discussion of General Electric will show you what I mean. The tickers above are among the heaviest and the lightest net debt balances on the S&P 500 index.

AT&T has borrowed billions of dollars to build and support its nationwide network of wired and wireless communications services. Ma Bell is balancing $2.5 billion in cash reserves against $76 billion of long-term debt -- and plans to drive this debt load up even further if the proposed buyout of DIRECTV (NASDAQ: DTV  ) passes regulatory muster. Building and running a serious telecom business like AT&T's takes a lot of capital investment, which leads to this tilted enterprise value.

Like AT&T, General Electric also runs a capital-heavy business with lots of expensive manufacturing facilities. Furthermore, GE also acts like a giant bank. GE Capital represents 45% of GE's total earnings these days. This division holds a staggering $126 billion in cash equivalents and over $500 billion in total assets, balanced against $200 billion in long-term borrowings and many other investment-grade liabilities. If none of these terms sound familiar, you're probably not terribly familiar with the banking sector and might want to tread lightly around the almost-a-bank we call General Electric.

These two stocks show how market caps sometimes undervalue the actual company. AT&T's untold miles of copper cable and optical fiber are an essential part of the business model, as are GE's massive banking operations. And it's unfair to forget about the debt they carry to keep the wheels turning. That's why these stocks are worth more -- certainly to a potential buyout baron but also to informed investors of every stripe -- than their market caps would tell you.

The flip side
The same argument holds true on the other of the coin. Facebook runs a lean business model with gross margins north of 50%, based more on online services than on physical products. Qualcomm does ship physical products but boasts even higher gross margins of about 60%. The semiconductor giant maximizes profits in part by outsourcing its manufacturing operations to specialists in that field. Thanks to these so-called "fabless" operations, Qualcomm's capital needs are low, margins are high, and the company piles up cash reserves on a debt-free balance sheet.

Nobody expects Facebook or Qualcomm to be acquired anytime soon. Their cash balance discounts offer something like a 10% discount to their plain market caps, but we're still looking at takeout bills of epic proportions. I would still encourage you to take a second look at their balance sheets when setting a target price or sketching up an investing thesis.

If nothing else, these huge imbalances could mean that Facebook and Qualcomm should try a little bit harder to return value to their investors. Buybacks and dividends generally don't move market caps around, but they do reduce cash reserves and hike up enterprise values. Most megacap stocks have larger enterprise values than market caps, along the lines of AT&T or General Electric. Perhaps the tech giants should strive to join that club.

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