EV to Assets Valuation

EV, or Enterprise value, divided by Assets, is one of the key valuation ratios in financial terminology, which help measure a company’s worth. Several other ratios arrived by dividing various financial metrics by EV, and this is perhaps one of the most significant of all these ratios.

Like most other financial ratiosFinancial RatiosFinancial ratios are indications of a company’s financial performance. There are several forms of financial ratios that indicate the company’s results, financial risks, and operational efficiency, such as the liquidity ratio, asset turnover ratio, operating profitability ratios, business risk ratios, financial risk ratio, stability ratios, and so on.read more, EV to Assets has its advantages and disadvantages as far as revealing valuable information about the worth of a company is concerned. However, it would be essential to define some key concepts before moving on to the same.

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What is Enterprise Value (EV)?

Enterprise Value Enterprise Value Enterprise value (EV) is the corporate valuation of a company, determined by using market capitalization and total debt.read moreis thought of as representative of the company’s actual value, which considers both its equity and debt to arrive at a realistic figure of what a company is truly worth. Unlike market capitalization, which looks at equity in isolation, EV helps paint a more realistic picture of the value of a business by adding debt to the figure.

EV is often contrasted against Market CapitalizationMarket CapitalizationMarket capitalization is the market value of a company’s outstanding shares. It is computed as the product of the total number of outstanding shares and the price of each share.read more for their difference in the approach adopted for evaluating a company. EV can also be considered the ‘takeover price’ of a business, which is why cash and its equivalents are deducted from the total debt to give an idea of the Debt minus cash and cash equivalents equals net debt, which is the amount of debt a company has in comparison to its liquid assets. It is a metric that is used to evaluate a firm’s financial liquidity and aids in determining if the company can meet its obligations by comparing liquid assets to total debt.read morenet debtNet DebtDebt minus cash and cash equivalents equals net debt, which is the amount of debt a company has in comparison to its liquid assets. It is a metric that is used to evaluate a firm’s financial liquidity and aids in determining if the company can meet its obligations by comparing liquid assets to total debt.read more that would need to be paid after the business acquisition.

Enterprise Value Formula = Market Capitalization + Debt + Minority InterestMinority InterestMinority interest is the investors’ stakeholding that is less than 50% of the existing shares or the voting rights in the company. The minority shareholders do not have control over the company through their voting rights, thereby having a meagre role in the corporate decision-making.read more + Preferred Shares – Cash and Cash Equivalents

What are Assets?

It would be important here to understand what constitutes a company’s assets in the first place. These include long-term business assets, such as real estate, and current assetsCurrent AssetsCurrent assets refer to those short-term assets which can be efficiently utilized for business operations, sold for immediate cash or liquidated within a year. It comprises inventory, cash, cash equivalents, marketable securities, accounts receivable, etc.read more, such as receivables. They can also be defined as core assets, which might have a direct role in business operations, and non-core assets, which have a little direct role in business operations. Depending on how assets are defined within a particular context, can the utility of this valuation multiple be measured?

EV to Assets Formula

EV/Assets = Enterprise Value {Market Capitalization + Debt + Minority Interest + Preferred Shares – Cash and Cash Equivalents} Cash And Cash Equivalents} Cash and Cash Equivalents are assets that are short-term and highly liquid investments that can be readily converted into cash and have a low risk of price fluctuation.  Cash and paper money, US Treasury bills, undeposited receipts, and Money Market funds are its examples. They are normally found as a line item on the top of the balance sheet asset. read more/ Assets

EV to Assets Examples

Let us look at the below calculation of EV to Assets.

  • Company ABC: Enterprise Value (31 Million) / Assets (22 Million) = 1.409 (EV to Assets)Company XYZ: Enterprise Value (23 Million) / Assets (20 Million) = 1.15 (EV to Assets)

Here it can be seen that the company with a lower EV to Assets value, i.e., Company XYZ is a much better choice than Company ABC because of a higher proportion of assets compared to its enterprise value.

With this, let us look at an example from the Oil & Gas sector.

source: ycharts

Suppose we do not consider any other valuation parameter and go only by EV to Assets. We note that the EV to Assets of Exxon Mobil, Royal Dutch Shell, and BP are 1.27x, 0.72x, and 0.59x. In that case, BP is a better choice as it has a higher proportion of Assets when compared to its enterprise value.

Advantages & Disadvantages of EV to Assets Valuation Multiple:

  • EV to Assets is a key valuation multiple, as discussed above. It is especially useful if the business is asset-driven, and Return On AssetsReturn On AssetsReturn on assets (ROA) is the ratio between net income, representing the amount of financial and operational income a company has, and total average assets. The arithmetic average of total assets a company holds analyses how much returns a company is producing on the total investment made.read more  (ROA) is more or less constant. It would also make assets the perfect indicator of Future Cash Flows (FCF).A high EV to Assets multiple would indicate the business is overvalued concerning the value of its assets, and if it’s on the lower side, the business is undervalued.This valuation multiple helps look at an investment from the point of view of its capital structure. It gives a fundamental idea of the value of an investment, especially in asset-driven industries. Keeping the total value of the capital structure of a business in mind, investors can better understand if the face value is attractively priced to buy its debt, if nothing else.Assets are one of the key determinants of the value of a firm, which might be of immense utility in helping understand the actual worth of a business. However, the value of certain types of assetsCertain Types Of AssetsAssets are the resources owned by individuals, companies, or governments expected to generate future cash flows over a long period. There are broadly three types of asset distribution: 1. Based on convertibility (current and non-current assets), 2. Physical existence (tangible and intangible assets), 3. Usage (operating and non-operating assets)read more, for instance, intangible assets, can more than often stand on mere assumptions. On the other hand, even fixed assets might be entangled in issues that can affect their actual worth.It must always be remembered that assets can be defined and categorized in various ways, which can play into this figure and lead to an erroneous impression of what a business might be worth in terms of its capital structure.

Conclusion: EV to Assets

This valuation multiple has its limitations and drawbacks. Still, it offers a unique perspective of the company’s worth by considering its total assets against its actual worth, as measured by EV or enterprise value. It can be used with a considerable advantage in comparable company analysisComparable Company AnalysisComparable comps are nothing but identifying relative valuations like an expert to find the firm’s fair value. The comparable comp process starts with identifying the comparable companies, then selecting the right valuation tools, and finally preparing a table that can provide easy inferences about the fair valuation of the industry and the company.read more which would give a fair idea of where a company stands against its peers in terms of its capital structure.

Considering its limitations, EV to Assets can be a useful financial metric for anyone willing to invest in a business, along with other enterprise valuation multiples. Problems with this metric are pretty obvious to anyone with a practical idea of how assets might be exaggerated on the balance sheets or evaporate in thin air the moment their real worth is estimated, all too often with intangible assetsIntangible AssetsIntangible Assets are the identifiable assets which do not have a physical existence, i.e., you can’t touch them, like goodwill, patents, copyrights, & franchise etc. They are considered as long-term or long-living assets as the Company utilizes them for over a year. read more. DepreciationDepreciationDepreciation is a systematic allocation method used to account for the costs of any physical or tangible asset throughout its useful life. Its value indicates how much of an asset’s worth has been utilized. Depreciation enables companies to generate revenue from their assets while only charging a fraction of the cost of the asset in use each year. read more in the value of assets is another factor, along with many legal and other issues that can even put a question mark on the true worth of fixed assets at times.

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