Here Is What You Need To Know About Earnings Multiplier In Business Valuation
June 3, 2018
A valuator may combine the use of more than one method of business valuation while analyzing the current worth of a company’s asset in the owner’s interest. One of the most commonly employed methods in this is the earnings multiplier. This method measures the company’s current share or stock’s market price in comparison to its earning on each share or earning per share (EPS). It is represented in the form of price per share/earnings per share and is also called as the price-to-earnings (P/E) ratio.
Why is it so useful in valuation?
The earnings multiplier helps to determine the change in the value of the prices of stocks, assets or shares of a company in the current market and know if there is a rise or fall in the value. The current market price is important in assuming how well the stocks may perform in future, that is, the future value and income of the company.
An acquiring company or a prospective buyer can rely on this information to get an idea of how well he would be benefitted on getting the ownership of this business. If the market price of the company’s assets is far too high or has an expensive historical background, it is an indication to rethink the suggestion of taking over. Another advantage is that when companies of similar nature are compared to their stock prices, the buyer can know the trend and how the expensive stock justified prices are in the current scenario. He will be able to estimate how proportionally he can earn with each share in the company by compensating for the expense he incurs on buying the shares.
For example, if the company used to earn 10$ when its price per share was 5$ and is currently providing an income of 12$ with a stock price of 8$, its P/E ratio indicates a negative curve and is currently expensive to buy. The owner, on the other hand, gets to know that there is still room for improving his income with respect to his shares and try for a better valuation.
It has two other purposes in valuation, namely:
- It can be used as a simple tool for valuation of comparing the relative value of shares or stocks of companies of similar nature.
- It can be used as a tool for determining the current stock prices of a company against their price history relative to their earnings.