Investment Valuation: Tools and Techniques for Determining the Value of Any Asset, Third Edition

CHAPTER 18

Earnings Multiples

Earnings multiples remain the most commonly used measures of relative value. This chapter begins with a detailed examination of the price-earnings ratio and then moves on to consider variants of the multiple—the PEG ratio and relative PE. It also looks at value multiples, and, in particular, the Enterprise Value to EBITDA multiple in the last part of the chapter. The four-step process described in Chapter 17 is used to look at each of these multiples.

PRICE-EARNINGS RATIO

The price-earnings (PE) multiple is the most widely used and misused of all multiples. Its simplicity makes it an attractive choice in applications ranging from pricing initial public offerings to making judgments on relative value, but its relationship to a firm's financial fundamentals is often ignored, leading to significant errors in applications. This chapter provides some insight into the determinants of price-earnings ratios and how best to use them in valuation.

Definitions of PE Ratio

The price-earnings ratio is the ratio of the market price per share to the earnings per share:

PE = Market price per share/Earnings per share

The PE ratio is consistently defined, with the numerator being the value of equity per share and the denominator measuring earnings per share, which is a measure of equity earnings. The biggest problem with PE ratios is the variations on earnings per share used in computing the multiple. In Chapter 17, we saw that PE ratios could be computed using ...