A multiple approach is a process for valuating a firm’s assets. Investors use this approach when determining the attractiveness of a company’s stock. Individuals also can use this process when comparing the financial information of multiple companies for non-investment purposes. For example, this approach is common when comparing profits margins or cash flow. This analysis is often specific to a single business industry or sector, measuring each firm’s strength in the overall market.
When valuing a company’s stock, the price to earnings formula is often seen as one of the most important figures. Earnings per share is calculated by taking net income less dividends divided by the average outstanding shares of stock. This lets investors know how much money the company can reinvest back into operations to generate more value in the future. The multiple approach takes this valuation one step further. Investors will divide the current stock price by the latest earnings per share released by the company. This will result in a figure known as the multiple, which helps investors estimate the future price for the company’s stock. For example, a multiple of 12 and future earnings per share of $2.50 US Dollars (USD) will indicate the stock price should increase to $30 USD. Investors will then determine if the multiple approach is suitable for estimating future stock price increases or decreases.
The multiple approach allows investors to compare the potential value growth of a variety of companies in the overall market. The multiple also indicates whether the company is higher or lower than similar firms, which can result in fewer investors seeing the company’s stock as a worthy investment. For example, the company’s multiple of 12 is less favorable if the industry’s average multiple is 15. This means the company will experience less growth if earnings per share is comparable among the companies within the industry.
Individuals — both investors and non-investors — can use a multiple approach to evaluate companies through gross profit measurements. This allows for the comparison of companies in a method outside of stock price. The gross profit ratio is calculated by figuring sales less cost of goods sold divided by sales. This multiple approach helps show how much money the company has left to pay operating expenses and stakeholders in the company. This figure allows for the comparison of companies in different industries, making the multiple approach more attractive than the stock multiple. The comparison of gross profit is key for determining whether companies can remain competitive and in business for future years.
