Multiple Compression

AAA

DEFINITION of 'Multiple Compression'

The effect that arises when a stock trades at a certain multiple and, while earnings may be strong, the stock price doesn't move up (or even goes down). The result is that the given multiple (P/E ratio) is reduced even though nothing is fundamentally wrong with the company. Compression of a company's multiple can be interpreted as the valuation being called into question.

INVESTOPEDIA EXPLAINS 'Multiple Compression'

Remember, the multiple is based off of many factors, but most importantly the future expectations of a company. If a company trades at say, a P/E multiple of 50, this means investors are paying $50 for each $1 of earnings. Generally, an investor would only pay such a high multiple on the expectation that the company will grow significantly faster than its competitors or the stock market in general. When the company's growth rates start to slow, investors might start to doubt its growth prospects, and thus not pay an expensive a premium as they once did. In our case, the company might experience multiple compression with the P/E shrinking to 25, even though earnings haven't changed. With the same earnings of $1, this would mean that the stock price fell in half (25/50 = 1/2). This demonstrates how the stock price could go down when earnings stay the same.

RELATED TERMS
  1. Multiple

    A term that measures some aspect of a company's financial well-being, ...
  2. Price-Earnings Ratio - P/E Ratio

    A valuation ratio of a company's current share price compared ...
  3. Forward Earnings

    A company's forecasted, or estimated, earnings made by analysts ...
  4. Valuation

    The process of determining the current worth of an asset or company. ...
  5. Earnings Multiplier

    An adjustment made to a company's P/E ratio that takes into account ...
  6. Financial Singlularity

    A financial singularity is the point at which investment decisions ...
RELATED FAQS
  1. What kind of assets can be traded on a secondary market?

    Virtually all types of financial assets and investing instruments are traded on secondary markets, including stocks, bonds, ... Read Full Answer >>
  2. What is considered a healthy EV/EBITDA?

    While average EV/EBITDA values vary by sector and industry, a general guideline is an EV/EBITDA value below 10 is commonly ... Read Full Answer >>
  3. What constitutes a secondary market?

    A secondary market covers the trading of any good, commodity, security or asset after it has been issued or created. Although ... Read Full Answer >>
  4. How are American Depository Receipts (ADRs) exchanged?

    American depositary receipts (ADRs) are bought and sold on regular U.S. stock exchanges, either in the over-the-counter market ... Read Full Answer >>
  5. What are the differences between global depositary receipts (GDRs) and American depositary ...

    A global depositary receipt (GDR) is a bank certificate issued in multiple countries for shares in a foreign company. The ... Read Full Answer >>
  6. What are the main factors that affect stocks in the telecommunications sector?

    It is tempting to think that share prices in different sectors are controlled by unique underlying principles, but this is ... Read Full Answer >>
Related Articles
  1. Fundamental Analysis

    Ratio Analysis Tutorial

    If you don't know how to evaluate a company's present performance and its possible future performance, you need to learn how to analyze ratios.
  2. Markets

    PEG Ratio Nails Down Value Stocks

    Learn how this simple calculation can help you determine a stock's earnings potential.
  3. Markets

    Understanding The P/E Ratio

    Learn what the price/earnings ratio really means and how you should use it to value companies.
  4. Markets

    Introduction To Fundamental Analysis

    Learn this easy-to-understand technique of analyzing a company's financial statements and reports.
  5. Fundamental Analysis

    Calculating Valuation

    Valuation is the process of determining what an asset is worth.
  6. Economics

    Do Transport Stocks Signal a U.S. Selloff?

    The Dow Jones Transportation Average index has underperformed the broader DJ Industrials Average, leading some market watchers to speculate a selloff.
  7. Investing Basics

    Explaining Counterparty Risk

    Counterparty risk is the risk that the other party in an agreement will default, or fail to live up to its contractual obligation.
  8. Fundamental Analysis

    Calculating the Capacity Utilization Rate

    Capacity utilization rate is a ratio used to compare a current usage level against a maximum potential level.
  9. Investing

    What Can A Conference Call Tell About Trends?

    Messages in a company conference call can be easily misconstrued. But there is a way to cut through the talking points to get to the real substance.
  10. Fundamental Analysis

    Do Fast Food Franchises Mean Fast Returns?

    We look at what it takes to own a fast food franchise: the entry costs, profit potentials, challenges, and sustainability.

You May Also Like

Hot Definitions
  1. Unfair Claims Practice

    The improper avoidance of a claim by an insurer or an attempt to reduce the size of the claim. By engaging in unfair claims ...
  2. Killer Bees

    An individual or firm that helps a company fend off a takeover attempt. A killer bee uses defensive strategies to keep an ...
  3. Sin Tax

    A state-sponsored tax that is added to products or services that are seen as vices, such as alcohol, tobacco and gambling. ...
  4. Grandfathered Activities

    Nonbank activities, some of which would normally not be permissible for bank holding companies and foreign banks in the United ...
  5. Touchline

    The highest price that a buyer of a particular security is willing to pay and the lowest price at which a seller is willing ...
  6. Himalayan Option

    An exotic equity option belonging to a class known as mountain range options. Himalayan options are based on a basket of ...
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!