Equity Value

What is Equity Value?

Equity value is a measure for assessing the overall returns generated for the equity shareholders of the company and can be indirectly derived from the Enterprise value by adjusting for those items which are available to be paid to equity shareholders after all liabilities are paid off and the interests and claims of other capital providers are duly met.

Explanation

This incorporates the value of the stock options and warrants which are issued but not yet exercised and also those shares arising out of the convertible securities such as bonds or preference shares based on the predetermined conversion ratio.

This is a much broader term as compared to the market capitalization of the company’s stock because market capitalization only values the outstanding shares at the current market price, while it also incorporates the share of equity holders in addition to such market cap, such as that in the assets of the company, once all prior claims are settled.

Formula for Equity Value

There can be multiple ways in which can be calculated, either it can be derived from the Enterprise value or it may be separately calculated, which again has two methods as per the below flow chart:

1. Formula for Equity Value

2. Formula for Intrinsic Value

Points to Note:

• Only in the money stock options are considered
• Proceeds from exercise of stock options or convertible securities are used for repurchase of existing shares from the market to reduce the number of shares outstanding as new shares also get issued from the exercise of these options.

3. Formula for Fair Value

Points to Note:

• All stock options are considered whether in the money or out of the money
• Valuation of stock options uses models such as the Black Scholes Option Pricing Method or other similar models
• Excess value implies the value of convertible securities greater than the value of similar securities that don’t have the conversion option. The conversion option increases the value of such securities because the security holders have an option to convert the securities into equity and participate in the growing return prospects.

Each of these methods might lead to a different Equity value because the intuition that goes into them is different. It boils down to the analyst’s judgment, which method is most appropriate for the given company.

Examples of Equity Value

Let’s take an example to understand the calculation in a better manner.

Example #1

Let’s take up a simple example and derive the Equity value from the enterprise value. Suppose below is the given information:

Solution:

Equity Value is calculated using the formula given below

Equity Value = Enterprise Value – Market Value of Preference Shares – Market Value of Debt -Minority Interest + Cash and Cash Equivalents + Short & Long Term Investments

• Equity Value = 2575000 – 360000 – 625000 – 100000 + 10000 + 200000
• Equity Value = 1700000

Therefore, the equity value is $1700000, however, if we back-calculate the equity component of the enterprise value, it will be lesser.

Enterprise Value is calculated using the formula given below

Enterprise Value = Market Value of Equity + Market Value of Preference Shares + Market Value of Debt + Minority Interest – Cash and Cash Equivalents

• 2575000 = Market Value of Equity + 360000 + 625000 + 100000 – 10000
• Market Value of Equity = 1500000

The difference in the values is because of the existence of investments which is not considered in the calculation of Enterprise value, and therefore if we consider the market value, we ignore the effect of investments, which might also bring the returns for the long term investor and therefore lead to an underestimation of expected return.

Importance

• As conveyed earlier, This is a much broader term than the market capitalization and therefore, this represents the interests of the equity investors much more comprehensively. A retail investor or a short term investor can benefit from the analysis of only the market cap, however, a long term investor should understand and analyze because his interests are deeper and the impact of various components will impact his returns in the long term because his returns might get diluted over time.
• It is a valuable metric for M&A analysis because, at times, the acquirer only invests in the assets of the target company and not in the liabilities, and for such an investor, this is more important than the total enterprise value depending upon the degree of control desired and exercised by it.

Difference between Equity Value and Enterprise Value

• Meaning: This is a narrower concept as it pertains to only the interests. Enterprise value is more comprehensive or a broader measure because it is the value of the company as a whole.
• Purpose: This should be used by an investor who is only interested in the equity aspect of the company and not in the debt or liability aspect. It is more appropriate for the investors who want to know the value of the residual claims and also in case of an M&A transaction wherein the acquirer is only interested in the assets of the company. Enterprise value is of the concern of an investor who wants to take over the entire company including the debt and the liabilities.

Conclusion

So we understand that the Equity value is more than just the market capitalization of the equity share, as it considers the value of unexercised stock options and conversion options of the convertible securities. It is useful for the investors who want to invest in the equity of the company for the long term and therefore need to know about the return on their investment on a diluted equity level so that they can understand the true nature of their investment.

Recommended Articles

This is a guide to the Equity Value. Here we discuss how to calculate along with practical examples. We also provide a downloadable excel template. You may also look at the following articles to learn more –

1. Return on Equity
2. Equity Ratio Formula
3. Equity Examples
4. Stockholder’s Equity Formula