Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail
Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

Earnings Multiplier

What it is:

The earnings multiplier, also called the price-to-earnings ratio (P/E), is a valuation method used to compare a company’s current share price to its per-share earnings.

How it works (Example):

The market value per share is the current trading price for one share in a company, a relatively straightforward definition. However, earnings per share (EPS) may not be as intuitive for most investors. The more traditional and widely used version of the EPS calculation comes from the previous four quarters of the price-to-earnings ratio, called a trailing earnings multiplier or trailing P/E. Another variation of the EPS can be calculated using a forward earnings multiplier, estimating the earnings for the upcoming four quarters. Both sides have their advantages, with the trailing earnings multiplier approach using actual data and the forward earnings multiplier predicting possible outcomes for the stock. Calculated as the following:

Earnings Multiplier = Market value per share / Earnings Per Share (EPS)

Moving on from the basics, let us do a sample calculation with company XYZ that currently trades at $100 and has an earnings per share (EPS) of $5. Using the previously mentioned formula, you can calculate that XYZ’s earnings multiplier is 100 / 5 = 20.

Why it Matters:

The earnings multiplier is a powerful, but limited tool. For investors, it allows a quick snapshot of the company’s finances without getting bogged down in the details of an accounting report.

Let us use our previous example of XYZ, and compare it to another company, ABC. Company XYZ has an earnings multiplier of 20, while company ABC has an earnings multiplier of 10. Company XYZ has the highest earnings multiplier of the two; this would lead most XYZ investors to expect higher earnings in the future than from ABC (which possesses a lower earnings multiplier ratio).

As noted earlier, the earnings multiplier is limited. It does not paint the entire picture for the potential investor; rather it is a complementary tool in your financial toolbox. Be wary of forward EPS measures, (remember, EPS is an essential aspect of calculation of the earnings multiplier) as they are matters of prediction and are only estimates of projected earnings. Further, trailing earnings multipliers can only tell you what happened to a company in the previous time periods.