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A valuation multiple is a ratio that compares a company's market price to one of its financial metrics. The most common multiple is the price-to-earnings (PE) ratio, which divides the stock price by earnings per share.
A PE of 15 means investors pay $15 for every $1 of annual earnings. A PE of 20 means they pay $20 for every $1 of earnings. Lower multiples suggest a stock is cheaper relative to its earnings, but cheaper isn't always better.
Price-to-Book (PB): Compares stock price to book value per share. Useful for asset-heavy businesses like banks. A PB below 1.0 suggests the stock trades below its accounting value.
Price-to-Sales (PS): Compares stock price to revenue per share. Useful when companies are unprofitable. A low PS can signal undervaluation, but revenues without profits eventually matter.
EV/EBITDA: Enterprise value divided by earnings before interest, taxes, depreciation. Useful for comparing companies with different debt levels and tax situations.
Never rely on multiples alone. A low PE might mean a stock is cheap, or it might mean the company's earnings are in decline. You must understand why the multiple is low.
Compare multiples across similar companies in the same industry. A biotech company's PE might be 30x while a utility's is 15x—both might be reasonable for their respective industries and growth prospects.