Enterprise value is the sum of a firm’s market capitalisation and its net debt (short- and long-term debt minus cash). It measures the value of a firm as represented by the contribution made by external banks and shareholders.
By comparing it to the sales figure (usually for the most recent 12-month period) you get a valuation ratio. So if a firm’s market capitalisation is £100m and its net debt is £150m, EV is £250m. If the sales figure is £25m, the EV/sales ratio is expressed as ten. The higher the multiple, the more highly rated the company.
There are some problems, however. For starters, the sales figure gives no indication of profitability or cash flow. So some analysts prefer to look at EV/Ebitda (earnings before interest, tax, depreciation and amortisation), or EV/cash flow instead.
• See Tim Bennett’s video tutorial: Beginner’s guide to investing: enterprise value.