What is a 'Multiple'
A multiple measures some aspect of a company's financial well-being, determined by dividing one metric by another metric. The metric in the numerator is typically larger than the one in the denominator.
For example, a multiple can be used to show how much investors are willing to pay per dollar of earnings, as computed by the price-to-earnings (P/E) ratio. Assume you are analyzing a stock with $2 of earnings per share (EPS) that is trading at $20. This stock has a P/E ratio of 10. This means investors are willing to pay a multiple of 10 times the current EPS for the stock.
BREAKING DOWN 'Multiple'
In the world of stock valuation, there are two different valuation methods: one is based on cash flow, and the other is based on a multiple of some performance measure, such as the earnings or sales. Valuation based on cash flow is considered to be an intrinsic valuation, and valuation based on a multiple is considered to be relative, because the multiple is relative to some performance measure.
Commonly Used Multiples
The most common multiple used in the valuation of stocks is the P/E multiple. It is used to compare a company's market value with its earnings. A company with a price or market value that is high compared to its level of earnings has a high P/E multiple. A company with a low price compared to its level of earnings has a low P/E multiple. A P/E of 5x means a company’s stock is trading at a multiple of five times its earnings. A P/E of 10x means a company is trading at a multiple that is equal to 10 times earnings. A company with a high P/E is considered to be overvalued. Likewise, a company with a low P/E is considered to be undervalued.
Other commonly used multiples include the enterprise value (EV) to earnings before interest, taxes, depreciation and amortization (EBITDA) multiple, also referred to EV/EBITDA. It is used to measure the cash flow available to the firm. EV to earnings before interest and taxes (EBIT), also referred to as EV/EBIT, is used for less capital-intensive companies with a small depreciation and amortization expense. The EV to sales ratio, also referred to as EV/Sales, is a multiple that companies with negative earnings often use. All multiples act as a single number that analysts can multiply by some financial metric to determine the relative value.