Valuation Multiple

What Is a Valuation Multiple?

In investing, a valuation multiple is a ratio that divides a measure of what a company is worth, such as its market capitalization or enterprise value, by a measure of what it earns, sells, or generates in cash. People often shorten the phrase to "multiple." The result is usually read as a number followed by "times." A multiple of 20 means the company's value is twenty times the chosen financial figure.

How It Works

The top of the ratio is a value measure and the bottom is a performance measure. Common examples include:

• Price-to-earnings (P/E): share price divided by earnings per share, often called the price-to-earnings ratio.
• Enterprise value to EBITDA: total enterprise value divided by earnings before interest, taxes, depreciation, and amortization.
• Price-to-sales: market capitalization divided by annual revenue.

The P/E multiple is calculated as:

P/E multiple = Share price ÷ Earnings per share

For example, if a stock trades at $50 and the company earned $2 per share over the past year, its P/E multiple is 25. Investors are paying $25 for each dollar of annual earnings.

Why It Matters to Investors

Multiples let investors compare companies of different sizes, and compare a company with its own history or with peers in the same industry. A higher multiple often reflects expectations of faster growth or lower risk. A lower multiple may signal slower growth, higher risk, or an undervalued stock. Multiples are not conclusive on their own. They depend on the accounting methods used, on one-time items in the earnings figure, and on the industry. Mature utilities and fast-growing software companies normally trade at very different levels, so comparisons are most useful within the same sector.

Changes in multiples over time also matter. A rise in the multiple is sometimes called multiple expansion, and a fall is called multiple compression. Either can drive a stock's price even when the underlying earnings do not change.