DEFINITION of 'Multiple Compression'

Multiple compression is the effect that arises when a stock sees its earnings increase, but 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 on 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. Enterprise Multiple

    Enterprise multiple is a measure (the company's enterprise value ...
  2. Price-Earnings Ratio - P/E Ratio

    The Price-to-Earnings Ratio or P/E ratio is a ratio for valuing ...
  3. Forward Price To Earnings - Forward ...

    Forward price to earnings (forward P/E) is a measure of the price-to-earnings ...
  4. Trailing Price-To-Earnings - Trailing ...

    The sum of a company's price-to-earnings, calculated by taking ...
  5. Margin Pressure

    A financial term for the effect of certain internal or market ...
  6. Multiple Discriminant Analysis ...

    A statistical technique used to reduce the differences between ...
Related Articles
  1. Investing

    Here's How Relative Valuation Can Be a Trap

    Valuing a company through relative valuation to identify low-priced companies with strong fundamentals can make for deceiving looking bargain stocks.
  2. Investing

    Is Now the Time to Invest Internationally?

    The international markets have outperformed the S&P 500 since July. Here's why.
  3. Investing

    What Lies Ahead for Apple's P/E ratio

    Recently, Apple's P/E multiple has come down to levels equal to the S&P 500. What does the future hold for the tech giant's P/E ratio?
  4. Investing

    The 4 basic elements of stock value

    Investors use these four measures to determine a stock's worth. Find out how to use them.
  5. Investing

    How Do I Calculate the Price-Earnings Ratio?

    If Apple is trading at $108.73 per share, and its trailing twelve months' EPS is $6.45, calculate the P/E ratio as...
  6. Investing

    8 Blue Chip Stocks with Low P/E Ratios

    Discover why the price/earnings (P/E) ratio is important in determining the relative value of a stock and find out which S&P 500 stocks have the lowest P/E ratios.
  7. Trading

    Stocks With Multiple Tops: Breaking Higher or Lower?

    These four stocks have bumped up against a resistance level multiple times, but haven't broken out. Like a wound up spring, eventually these stocks will break higher, piercing through multiple ...
  8. Investing

    5 must-have metrics for value investors

    In this article, we outline the five ratios that can help value investors find the most undervalued stocks in the market.
  9. Investing

    4 Cases When Companies May Deserve a Higher P/E Ratio (AMZN, ZBH)

    Find out why the price-to-earnings ratio is high for some companies. Learn about the impact of growth rates, acquisition speculation and non-recurring charges.
RELATED FAQS
  1. What is the average price-to-earnings ratio in the banking sector?

    Explore the price/earnings ratio in regard to the banking industry and learn what the average P/E ratio is for most banking ... Read Answer >>
  2. How do I calculate the P/E ratio of a company?

    The P/E ratio shows whether a company's stock price is overvalued or undervalued and can reveal how a stock's valuation compares ... Read Answer >>
  3. What is the difference between forward p/e and trailing p/e?

    Understand the difference between the trailing P/E ratio, which is the standard price-to-earnings calculation, and the forward ... Read Answer >>
  4. Why Are P/E Ratios Higher When Inflation Is Low?

    P/E ratios are generally higher during times of low inflation, but why is this the case? Read Answer >>
  5. What is the average price-to-earnings ratio in the financial services sector?

    Learn how to calculate and use the price to earnings (P/E) ratio when analyzing an investment and what the financial services ... Read Answer >>
  6. What is the average price-to-earnings ratio in the drugs sector?

    Learn what the average price-to-earnings ratio is for companies operating in the drugs sector and why this metric is important ... Read Answer >>
Hot Definitions
  1. Investment Advisor

    An investment advisor is any person or group that makes investment recommendations or conducts securities analysis in return ...
  2. Gross Margin

    A company's total sales revenue minus its cost of goods sold, divided by the total sales revenue, expressed as a percentage. ...
  3. Inflation

    Inflation is the rate at which prices for goods and services is rising and the worth of currency is dropping.
  4. Discount Rate

    Discount rate is the interest rate charged to commercial banks and other depository institutions for loans received from ...
  5. Economies of Scale

    Economies of scale refer to reduced costs per unit that arise from increased total output of a product. For example, a larger ...
  6. Quick Ratio

    The quick ratio measures a company’s ability to meet its short-term obligations with its most liquid assets.
Trading Center