Value Quest

Why can't they just say, 'Go to this place and here is the treasure; spend it wisely?'
--Riley Poole (National Treasure)

Recently some have opined that General Motors (GM) is a buy here because of its low market capitalization. Market capitalization, or 'market cap', is found by multiplying the number of shares outstanding in a stock (a.k.a. 'the float') by the share price.

market capitalization = number of shares outstanding * stock price

With a float of about 556 million shares and a share price of $10.17 (July 3rd close), GM's market cap is approximately $5.8 billion. As a component of the Dow Jones Industrial Average, GM's market cap is significantly lower than the other 29 stocks that comprise index. Next lowest are Alcoa (AA) at about $27 billion, and DuPont (DD) and Home Depot (HD) at about $38 billion.

Market cap is often viewed as a measure of overall company value. And, in the eyes of some, GM's low market cap reflects a company that is inexpensive and worthy of investment (or at least a trade).

As a measure of overall corporation value, however, market capitalization is incomplete since it does not directly account for a company's debt and cash positions. In the event of a buyout, the buyer would have to assume the company's debts while pocketing its cash.

A better reflection of takeover value is enterprise value. Enterprise value equals the company's market cap plus its debt (which could include minority positions and preferred stock) minus its cash.

enterprise value = market capitalization + debt - cash

GM's March 2008 balance sheet indicates total debt of about $44 billion and cash of about $22 billion which implies an enterprise value of about $28 billion. As such, GM's enterprise value is more than 4 times its market capitalization--due to the large amount of debt to be assumed by any would-be acquirer.

Big discrepancies between market cap and enterprise value are common, which shouldn't be too surprising given the degree of corporate leverage these days. As a further example, consider the other 'General' in the Dow 30, General Electric (GE). GE's market cap currently stands at nearly $270 billion. However, due to the company's half a trillion dollar debt load, GE's enterprise value balloons to about $800 billion.

When trying to get a picture of the overall value that the market is assigning to a company, enterprise value often adds perspective not offered by market capitalization alone.

position in GE