What is Price Multiple?
A price multiple is a market ratio that uses the current share value of a company in accordance with some specific per-share financial statement for a figure out on valuation.
Simply, the measurement of its current share value relative to its per-share earnings (EPS). The share value is typically divided by a chosen per-share metric to form a ratio.
Price multiples can be used for equity valuation in two ways: one is based on comparable and another based on fundamentals.
While using this ratio based on comparable, then it is calculated based on the actual market value of the stock.
It is compared to a benchmark to evaluate whether the stock is undervalued, overvalued, or fairly valued.
The common ratios are as follows:
- Price/Earnings (P/E)
- Price/Forward Earnings (P/FE)
- Price / Book Value (P/B)
- Price / Research (P/R)
- Price / Sales (P/S)
- Price / Total Assets (P/T)
- Price/ Tangible Book Value (P/TBV)
- Price /Cash Flow (P/CF)
- Price/EBITDA (P/EBITDA)
- Price/ Free Cash Flow (P/FCF)
Advantage of Price Multiple
- These are providing a static and forward glance at a stock’s valuation.
- These are easy to compile with on the surface.
- The multiples are used to compare present and future (forecasted) valuation multiples of a company with its historical figures and with those of its peers.
- The analysts are able to compute the fair value of the stocks.
- Investors are able to investment decisions.
- It would be an appropriate valuation measure for a technology firm.
- These are relatively easy to use, are based on actual market transactions, and can provide a useful ballpark for estimating a value for investors.
Disadvantage of Price Multiple
- It disguises a wide range of differences that may exist within a given industry.
- Investors have limitations only this is relevant to a given industry.
- There are no extraordinary items, one-offs, or non-recurring factors that may distort a normalized financial metric.
A company XYZ has a revenue of $20,000,000 per year. It has 1,000,000 shares outstanding. Today, the company’s stock value is $10 per share.
Using the formula above, we can calculate this ratio of company XYZ’s :
Price Multiple = $10 / ($20,000,000/1,000,000) = 0.50
In Company XYZ’s industry this ratio is below 0.80 multiple, implying that XYZ is undervalued with 0.50 multiple and good to invest in the company.
Interpretation and Analysis of Price Multiple
This is the most ordinarily used type of these ratios. The idea behind this is most stocks inside the same business or peer group ought to be exchanged at a comparable value.
When utilizing these ratio supported fundamentals, the price multiple is calculated supported the forecasted value of the stock calculated utilizing a valuation model, for instance, DDM.
In this method, an expert will initially calculate the reasonable value of a stock utilizing a valuation model, for example, the Constant Dividend Discount Model.
Then he will divide this reasonable value with one of the stock’s fundamentals, for example, earnings, sales, book value, or income to arrive at the ratio.
A ratio calculated utilizing fundamentals is additionally called justified multiple.
For example, if P/E proportion is calculated with a value derived utilizing the dividend markdown model, then it will be referred to as justified P/E.
Since such P/E is calculated utilizing the expected value of the stock, it is additionally referred to as leading P/E, as compared to trailing P/E where past information is used.
The justified P/E is the P/E at which the stock ought to be exchanged based on its fundamentals.
On the off chance that the P/E based on the market value is different from justified P/E it flags that the stock is undervalued or overvalued.
For example, if the justified P/E is 8, and the genuine P/E based on market value is 12, then the stock is overvalued, and vice verse.
These are typically used to gain some understanding about whether a company’s stock value (and subsequently a company’s value) is excessively high or excessively low.