Multiple Compression


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.

BREAKING DOWN '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.

  1. Price-Earnings Ratio - P/E Ratio

    The Price-to-Earnings Ratio or P/E ratio is a ratio for valuing ...
  2. Multiple

    A term that measures some aspect of a company's financial well-being, ...
  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. Put-Call Parity

    A principle that defines the relationship between the price of ...
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. Investing Basics

    What Does In Specie Mean?

    In specie describes the distribution of an asset in its physical form instead of cash.
  6. Economics

    Calculating Cross Elasticity of Demand

    Cross elasticity of demand measures the quantity demanded of one good in response to a change in price of another.
  7. Fundamental Analysis

    Emerging Markets: Analyzing Colombia's GDP

    With a backdrop of armed rebels and drug cartels, the journey for the Colombian economy has been anything but easy.
  8. Investing

    How to Win More by Losing Less in Today’s Markets

    The further you fall, the harder it is to climb back up. It’s a universal truth that is painfully apparent in the investing world.
  9. Fundamental Analysis

    Value Investing Strategies in a Volatile Market

    Volatile markets are a scary time for uneducated investors, but value investors use volatile periods as an opportunity to buy stocks at a discount.
  10. Stock Analysis

    The Biggest Risks of Investing in FireEye Stock

    Examine the current state of FireEye, Inc., and learn about some of the biggest risks of investing in this cybersecurity company's stock.
  1. Can working capital be too high?

    A company's working capital ratio can be too high in the sense that an excessively high ratio is generally considered an ... Read Full Answer >>
  2. How do I use discounted cash flow (DCF) to value stock?

    Discounted cash flow (DCF) analysis can be a very helpful tool for analysts and investors in equity valuation. It provides ... Read Full Answer >>
  3. Where do penny stocks trade?

    Generally, penny stocks are traded through the use of the Over the Counter Bulletin Board (OTCBB) and through pink sheets. ... Read Full Answer >>
  4. Where can I buy penny stocks?

    Some penny stocks, those using the definition of trading for less than $5 per share, are traded on regular exchanges such ... Read Full Answer >>
  5. How does the stock market react to changes in the Federal Funds Rate?

    The stock market reacts to changes in the federal funds rate in various ways depending on where it is in the business cycle. ... Read Full Answer >>
  6. What are the requirements for being a Public Limited Company?

    The requirements for an entity to be considered a public limited company (PLC) include registration requirements, establishing ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Capitalization Rate

    The rate of return on a real estate investment property based on the income that the property is expected to generate.
  2. Gross Profit

    A company's total revenue (equivalent to total sales) minus the cost of goods sold. Gross profit is the profit a company ...
  3. Revenue

    The amount of money that a company actually receives during a specific period, including discounts and deductions for returned ...
  4. Normal Profit

    An economic condition occurring when the difference between a firm’s total revenue and total cost is equal to zero.
  5. Operating Cost

    Expenses associated with the maintenance and administration of a business on a day-to-day basis.
  6. Cost Of Funds

    The interest rate paid by financial institutions for the funds that they deploy in their business. The cost of funds is one ...
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!