- Ensco's stock price has declined substantially after running up substantially in late December and early January.
- This article explains one key reason why Ensco's stock price is so volatile.
- Investors should keep this in mind when placing their bets.
Yesterday in Offshore Drillers: Key Metric To Watch In 2018, I explained to Value Portfolio subscribers that I will be a keeping a close eye on certain metrics throughout the upcoming quarters, and also discussed why the stock price of Ensco (ESV) is so volatile compared to oil equities in general:
First, let's review two key measures of corporate valuations.
What Is Market Capitalization?
Ensco currently has 436 million shares outstanding, so at the last closing price of $4.42, Ensco's market capitalization, or the market value of its equity, was $1.93 billion. This figure represents the market value of Ensco's equity.
The following graph illustrates how Ensco's market capitalization has trended in the last three years:
Market capitalization, however, does not tell the whole story.
What Is Enterprise Value?
Enterprise Value (not to be confused with Intrinsic Value) is a more comprehensive measure than market capitalization, and represents the market value of the business. The following graph illustrates how Ensco's enterprise value has trended in the last three years:
Readers should note Ensco's enterprise is currently at $5.79 billion, or three times of its market capitalization. This is primarily because of the company's total debt balance of $4.76 billion, which will have to be paid regardless of what the company's stock price does. In other words, the total debt balance is relatively constant, and when the market capitalization changes, what really changing is Enterprise Value minus Debt.
For illustration purposes, let's assume that, for whatever reason, the total price of the business (i.e. Enterprise Value) increases by 10 percent.
In this case, Ensco's enterprise value would increase from $5.79 billion to $6.37 billion. Since the debt balance of $4.76 billion remains relatively constant, the market capitalization of the company has now increased from $1.93 billion to $2.51 billion.
In other words, a 10 percent increase in the company's enterprise value (i.e. the market value of the business) has led to a 30 price increase in the company's market capitalization (i.e. the market value of the equity).
Ensco's stock price, along with the stock prices of companies with high debt-to-market capitalization ratios, is extremely volatile.
This is why when oil prices fluctuate, which changes investors' estimates of the company's prospects and the estimated value of the business, Ensco's market capitalization (i.e. stock price times shares outstanding) fluctuates wildly, essentially swinging around the relatively constant total debt balance.
Investors should place their bets accordingly, which could mean limiting use of margin debt, diversifying holdings in offshore drillers, using hedging strategies as they deem necessary, and so on.
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Analyst’s Disclosure: I am/we are long ESV. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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