A multiple measures the relationship of one financial aspect (of a company's business) to another.
Multiples are an important concept to understand because they help you evaluate whether a stock might be undervalued or overvalued. In general, multiples simply compare a stock's current price to something. For example, dividing the price by earnings (via a P/E ratio), revenue (via a price-to-sales ratio), book value (via a price-to-book ratio) or something else.
Imagine a company trading at $36 per share. It's expected to earn $3 per share this year, so its P/E on this year's earnings is 12 (36 divided by 3 equals 12). You might refer to it as trading at an earnings multiple of 12.
If you read analyses of various companies, you'll see references to price-to-sales multiples, book-value multiples, cash-flow multiples, and more. It's instructive to compare a company's various multiples with those of its competitors, to see how each is priced relative to its peers.
All things equal, a lower multiple hints at a stock being undervalued, while a higher multiple hints at a stock being overvalued. Care must be taken to ensure multiples are taken in the proper context, however. Relevant comps in terms of market capitalization, financial risk, and stage in the corporate life cycle should all be considered.
Just because a stock may appear cheap on a relative basis doesn't mean it is cheap in absolute terms. For example, a home that might have looked 5% undervalued on a relative basis in 2006 may have seemed a deal in relative terms, but not in the greater context that virtually the entire U.S. housing market was overvalued.
Related Fool Articles
Recent Mentions on Fool.com
- Is Facebook, Inc Ready to Prime the Instagram Advertising Pump?
- 3 Reasons 3M Co. Stock Could Fall
- Is It Time to Buy FedEx Stock?
- Why lululemon athletica Has Crashed 30% in 2014
- Did General Mills Waste $3 Billion of Your Money?
- Westport Innovations' Stock Is Down 80%: Are Natural Gas Vehicles a Dead Idea?