Earnings Multiplier

What Is the Earnings Multiplier?

The earnings multiplier is a financial metric that frames a company's current stock price in terms of the company's earnings per share (EPS) of stock, that is simply computed as price per share/earnings per share. Otherwise called the price-to-earnings (P/E) ratio, the earnings multiplier can be used as a simplified valuation tool with which to compare the relative costliness of the stocks of comparative companies. It can likewise help investors judge current stock prices against their historical prices on an earnings-relative basis.

Understanding Earnings Multiplier

The earnings multiplier can be a useful tool for determining how expensive the current price of a stock is relative to the company's earnings per share of that stock. This is an important relationship because the price of a stock is theoretically supposed to be a function of the anticipated future value of the responsible company and future cash flows resulting from ownership of that stock. Assuming that the price of a stock is historically expensive relative to the company's earnings, it might indicate that it's anything but an optimal time to purchase this equity because it's overly expensive. Furthermore, comparing earnings multipliers across comparative companies can help illustrate how expensive different companies' stock prices are relative to one other.

Example of the Earnings Multiplier

As an example of a practical application of the earnings multiplier, consider fictitious company ABC. Let's assume this corporation has a current stock price of $50 per share and earnings per share (EPS) of $5. Under this set of circumstances, the earnings multiplier would be 50 dollars/5 dollars per year = 10 years. This means it would take 10 years to make back the stock price of $50 given the current EPS.

The multiplier can likewise be verbally expressed by saying, "Company ABC is trading at 10 times earnings," because the current price of $50 is 10x the $5 EPS. In the event that 10 years prior, company ABC had a market price of $50 and EPS of $7, the multiplier would have been 7.14 years.

The earnings multiplier ought to simply be used to value investments on a relative basis and ought not be used to gauge an absolute valuation of a stock.

The current price would be more expensive relative to current earnings than the price 10 years prior because, at that time, the stock was just trading at 7.14 times earnings instead of 10 times earnings it trades at currently.

Comparing company ABC's earnings multiplier to other comparative companies can likewise provide a simple gauge for deciding how expensive a stock is relative to its earnings. In the event that company XYZ additionally has an EPS of $5, however its current stock price is $65, it has an earnings multiplier of 13 years. Consequently, this stock might be deemed to be relatively more expensive than the stock of company ABC, which has a multiplier of just 10 years.

Features

• The earnings multiplier frames a company's current stock price in terms of the company's earnings per share (EPS) of stock.
• This metric is computed as price per share/earnings per share.
• The earnings multiplier can help investors determine how expensive the current price of a stock is relative to the company's earnings per share of that stock.