Market multiple is the price/earnings ratio that compares a company’s stock price to its earnings per share. It helps investors predict future stock price movements and make decisions based on the multiple earnings approach. However, it can be flawed due to accounting manipulations and non-cash expenses.
A market multiple is another name for the price/earnings ratio of the investment term. This ratio compares a company’s current stock price to its current earnings per share. The basic calculation for market multiple is market value per share divided by earnings per share. For example, a company whose current stock price is $22.00 and current earnings per share of $1.40 has a multiple of 15.70. The multiple is often a predictor of future stock price movement.
Investors often calculate the market multiple using a company’s current quarterly information. Most companies release their earnings per share on a quarterly basis, making this the best time to get the information you need. In some cases, a company may provide information on a monthly or 12-month later basis. Using this information to calculate the multiple ensures that the investor has the most up-to-date information when comparing data on a company’s stock.
The market multiple allows investors to create future predictions for the company’s stock price. For example, in the previous example, a company’s market multiple is 15.70 based on current earnings of $1.40 per share. Most of the time, a company will provide forward estimates for next quarter’s earnings per share. If the company expects earnings to reach $1.75 per share, the stock price must equal the market several times the expected earnings per share. The new stock price is expected to be $27.48 at the end of next quarter.
Generally, increases in a company’s stock price are where most investors make money. Using the multiple market approach, investors can determine whether stocks in their portfolios will rise or fall in price over the next quarter. Investors can then buy or sell stocks in order to maximize expected earnings calculated using the multiple approach. Another term for this approach to stock analysis is known as the multiple earnings approach. A major benefit of this method comes from the readily available information on many stocks traded on stock exchanges.
Although simple in its approach, the multiple win method is not without its flaws. Among the most problematic issues is the use of accounting information to determine net income, which is how a company ultimately calculates earnings per share. Public companies may try to manipulate their net income by using aggressive or illegal accounting procedures. This can distort a company’s earnings per share and lead investors to make decisions on false assumptions. Companies with high non-cash expenses – such as depreciation or amortization – can also artificially lower net income, making the company appear less profitable and lowering earnings per share.
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