This paper aims to present a selection of the most used multiples and to point out their strengths and weaknesses. The financial markets have been deeply shaken by the spread of Covid-19 and the recent oil price shock. Also, the financial market crisis in 2008/2009 or the dotcom bubble in 2000, where many investors lost money, remain in bad memory for them. Therefore, when entering the stock market, the question arises which shares are worthwhile in the long run and at what price an investor should buy them.
There are different approaches to answer this question - one of them is the multiples approach, which has become a popular instrument for investors and financial analysts due to its simple statement and handling. According to the Merrill Lynch Institutional Factor Survey, the most popular factor used by institutional investors in stock selection was the price-earnings ratio (P/E ratio) followed by other multiples. First, the multiples approach in general is described. Afterwards, the P/E ratio with its variants is discussed in detail and in the third section, other frequently used multiples are presented. Finally, a critical appraisal is given.
Inhaltsverzeichnis (Table of Contents)
- Introduction
- The Multiples Approach
- Basic Concept and Procedure
- Creation of multiples and calculation of the company value
- Equity value multiples vs. Enterprise value multiples
- The P/E ratio
- Fundamentals
- The Trailing P/E ratio
- The Forward P/E ratio
- Forward vs. Trailing P/E ratio
- The PEG ratio
- Determining factors of the P/E ratio
- Other frequently used multiples
- The P/B ratio
- The P/S ratio
- The EV/EBITDA ratio
- Critical appraisal
Zielsetzung und Themenschwerpunkte (Objectives and Key Themes)
This paper aims to present a selection of the most used multiples in stock valuation and to highlight their strengths and weaknesses. The primary objective is to provide a clear understanding of the multiples approach, focusing specifically on the Price-to-Earnings (P/E) ratio and other commonly employed multiples. * The Multiples Approach to Stock Valuation * The Price-to-Earnings (P/E) Ratio and its Variations * Other Frequently Used Valuation Multiples (P/B, P/S, EV/EBITDA) * Strengths and Weaknesses of Multiple-Based Valuation * Application and Interpretation of Valuation MultiplesZusammenfassung der Kapitel (Chapter Summaries)
1 Introduction: This introductory chapter sets the stage by highlighting the impact of events like the COVID-19 pandemic and the 2008 financial crisis on investor confidence and the need for robust stock valuation methods. It introduces the multiples approach as a popular and readily accessible valuation technique, emphasizing its use by institutional investors, particularly the P/E ratio. The chapter establishes the paper's goal: to explore various multiples and assess their advantages and disadvantages. 2 The Multiples Approach: This chapter delves into the core principles of the multiples approach, explaining it as a market-oriented valuation method that leverages existing market prices. It emphasizes the approach's practical importance and relative ease of use, contrasting it with the Discounted Cash Flow (DCF) method. The chapter outlines the three main applications of multiples: verifying values from other methods, comparing company multiples, and valuing companies based on peer multiples. It further details the process, stressing the crucial role of identifying comparable companies (peer group) and the challenges in data acquisition and adjustment. 3 The P/E ratio: This chapter provides a comprehensive analysis of the P/E ratio, its variations (trailing and forward P/E), and the PEG ratio. It examines the fundamentals of the P/E ratio, explaining its calculation and interpretation. The chapter differentiates between trailing and forward P/E ratios, highlighting the importance of considering earnings expectations when using the forward P/E. It also delves into the PEG ratio, which incorporates growth rates, offering a more nuanced valuation approach. The chapter concludes by identifying key factors influencing the P/E ratio. 4 Other frequently used multiples: This chapter expands the discussion beyond the P/E ratio, exploring other widely used multiples such as the price-to-book (P/B) ratio, price-to-sales (P/S) ratio, and enterprise value-to-EBITDA (EV/EBITDA) ratio. For each multiple, it provides a basic description of how it is calculated and under what circumstances it may be most appropriate. The chapter provides a critical perspective on the different multiples and their potential applications in various valuation scenarios.Schlüsselwörter (Keywords)
Stock valuation, multiples approach, price-earnings ratio (P/E), price-to-book ratio (P/B), price-to-sales ratio (P/S), enterprise value-to-EBITDA (EV/EBITDA), financial analysis, investment analysis, peer group comparison, market-oriented valuation, discounted cash flow (DCF), trailing P/E, forward P/E, PEG ratio.
Frequently Asked Questions: A Comprehensive Guide to Stock Valuation Multiples
What is this document about?
This document provides a comprehensive overview of the multiples approach to stock valuation. It focuses on the most commonly used multiples, including the Price-to-Earnings (P/E) ratio, Price-to-Book (P/B) ratio, Price-to-Sales (P/S) ratio, and Enterprise Value-to-EBITDA (EV/EBITDA) ratio. The document explains how these multiples are calculated, interpreted, and applied in real-world scenarios, highlighting their strengths and weaknesses.
What is the multiples approach to stock valuation?
The multiples approach is a market-oriented valuation method that uses the market prices of comparable companies to estimate the value of a target company. It's a practical and relatively easy-to-use technique, contrasting with more complex methods like Discounted Cash Flow (DCF) analysis. This approach involves identifying comparable companies (peer group), gathering data, and applying various multiples to estimate the target's value. The approach is useful for verifying values from other methods, comparing company multiples, and directly valuing companies based on peer multiples.
What is the Price-to-Earnings (P/E) ratio, and how is it calculated?
The P/E ratio is a key valuation multiple that expresses a company's stock price relative to its earnings per share (EPS). It's calculated by dividing the market price per share by the earnings per share. The document distinguishes between trailing P/E (using past earnings) and forward P/E (using projected earnings), highlighting the importance of considering earnings expectations when using the forward P/E. The Price/Earnings to Growth (PEG) ratio, a variation of P/E, which incorporates growth rates, is also explained.
What are other frequently used valuation multiples besides the P/E ratio?
Besides the P/E ratio, the document details the Price-to-Book (P/B) ratio (market capitalization divided by book value of equity), the Price-to-Sales (P/S) ratio (market capitalization divided by revenue), and the Enterprise Value-to-EBITDA (EV/EBITDA) ratio (Enterprise Value divided by Earnings Before Interest, Taxes, Depreciation, and Amortization). Each multiple is described, along with its calculation and the circumstances where it might be most suitable.
What are the strengths and weaknesses of using multiples for valuation?
The document critically appraises multiple-based valuation, acknowledging its strengths (relative simplicity, market-based perspective, readily available data) and weaknesses (reliance on comparable companies, potential for manipulation of earnings figures, and sensitivity to market conditions). It emphasizes the importance of carefully selecting comparable companies and critically interpreting the results.
What are the key objectives and themes of this document?
The main objective is to provide a clear understanding of the multiples approach to stock valuation, focusing on the P/E ratio and other frequently used multiples. Key themes include: understanding the different types of multiples, their calculation and interpretation; identifying the strengths and weaknesses of multiple-based valuation; and applying these multiples in practical valuation scenarios.
What are the key chapters covered in this document?
The document covers an introduction to stock valuation and the multiples approach, a detailed explanation of the P/E ratio and its variations, an exploration of other commonly used multiples (P/B, P/S, EV/EBITDA), and a critical appraisal of the entire approach. Each chapter offers a comprehensive summary to facilitate understanding.
What keywords are associated with this document?
Keywords include: Stock valuation, multiples approach, price-earnings ratio (P/E), price-to-book ratio (P/B), price-to-sales ratio (P/S), enterprise value-to-EBITDA (EV/EBITDA), financial analysis, investment analysis, peer group comparison, market-oriented valuation, discounted cash flow (DCF), trailing P/E, forward P/E, PEG ratio.
- Quote paper
- Anonym (Author), 2020, Stock Analysis Methods. The P/E Ratio and other Multiples, Munich, GRIN Verlag, https://www.grin.com/document/916279
