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A price multiple is a ratio that uses the price of a share of stock, along with another financial metric, to provide information about the financial strength of the company. Comparing the same price multiple across different companies can help an investor understand which company may be the better investment. There are a number of commonly used price multiples, each of which provides different information about the company.
The price-to-earnings ratio compares the price of a share of a company’s stock to its earnings per share, or EPS. The price to earnings ratio, or P/E ratio, is the price of a share of stock divided by the company’s earnings per share as declared in its annual earnings statement. The price-to-earnings ratio is usually calculated on an annual basis, even though the earnings per share may be announced quarterly. The forward-price-to-earnings ratio, or forward P/E, compares the current stock price with expected earnings per share in the future.
The price/earnings-to-growth ratio, or PEG ratio, divides the price/earnings ratio by the company’s annual earnings per share growth. This price multiple is a popular indicator of the value of a company’s stock. It is similar to the price-to-earnings ratio, but it also accounts for growth. If the PEG ratio is low, the stock may be undervalued and therefore a good investment.
The price-to-book ratio, or P/B ratio, is a measure of the company’s share price compared to the company’s book value per share. The book value is defined as the company’s total assets, minus its intangible assets and liabilities. If the price-to-book ratio is low compared to others in the same industry, the company may be undervalued, or the company may have financial problems.
The price-to-cash-flow ratio compares the price per share to the company’s cash flow. This shows the company’s financial situation without considering depreciation and other non-cash factors. The price-to-sales, or price/sales, ratio is calculated by dividing the share price by the company’s annual revenue per share. The price-to-research ratio compares the price of the company’s stock with the amount spent on research and development.
Any price multiple is most useful when comparing different companies in the same industry. These ratios can vary widely from industry to industry. To get an accurate assessment of a company’s financial strength, compare its price multiples with those of its competitors. Many price multiples are used in Barra risk factor analysis, which attempts to measure the risk of a given company’s stock as an investment.
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