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), which is trading at $20. This stock has a P/E of 10. This means investors are willing to pay a multiple of 10 times the current EPS for the stock.
This is calculated as:
BREAKING DOWN Multiple
In the world of stock valuation, two major methods are based on cash flow and a multiple of some performance measure, such as the earnings or sales. Valuation based on cash flow (i.e. the discounted cash flow analysis) is considered to be an intrinsic valuation, while 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 (price) 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 widely considered to be a solid measure cash flow available to a firm and used by many equity analysts. EV to earnings before interest and taxes (EBIT), also referred to as EV/EBIT, is used for less capital-intensive companies, with fewer depreciation and amortization expenses. 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.