84. Valuation based on Price Multiples: p/e, p/bv, p/s.

The P/E ratio (price-to-earnings ratio) of a stock (also called its "P/E", or simply "multiple") is a measure of the price paid for a share relative to the annual net income or profit earned by the firm per share.[2] Unlike EV/EBITDA multiple, P/E reflects the capital structure of the company in question. P/E is a financial ratio used for valuation: a higher P/E ratio means that investors are paying more for each unit of net income, so the stock is more expensive compared to one with lower P/E ratio. The P/E ratio has units of years,[note 1] which can be interpreted as "number of years of earnings to pay back purchase price", ignoring the time value of money. In other words, P/E ratio shows current investor demand for a company share. The reciprocal of the P/E ratio is known as the earnings yield.[3] The earnings yield is an estimate of expected return to be earned from holding the stock if we accept certain restrictive assumptions (a discussion of these assumptions can be found here).

P/E is not a useful measure of financial performance of a company, because stock prices are very sensitive to investor expectations about the future. P/E days little about a company’s current financial performance, but indicates what investors believe about future prospects. P/B is used to compare a stock's market value to its book value. It is calculated by dividing the current closing price of the stock by the latest quarter's book value per share, or the company's market capitalization can be divided by the company's total book value from its balance sheet.

A lower P/B ratio could mean that the stock is undervalued. However, it could also mean that something is fundamentally wrong with the company. As with most ratios, it varies a fair amount by industry. Industries that require more infrastructure capital (for each dollar of profit) will usually trade at P/B ratios much lower than, for example, consulting firms. This ratio also gives some idea of whether you're paying too much for what would be left if the company went bankrupt immediately.

P/B ratios do not, however, directly provide any information on the ability of the firm to generate profits or cash for shareholders.

P/S is calculated by dividing a stock's current price by its revenue per share for the trailing 12 months, or by dividing the company's market cap by the company's revenue in the most recent year. The smaller this ratio (i.e. less than 1.0) is usually thought to be a better investment since the investor is paying less for each unit of sales. However, sales do not reveal the whole picture, as the company may be unprofitable with a low P/S ratio. Because of the limitations, this ratio is usually used only for unprofitable companies, since they don't have a price/earnings ratio (P/E ratio).[1] The metric can be used to determine the value of a stock relative to its past performance. It may also be used to determine relative valuation of a sector or the market as a whole. PSRs vary greatly from sector to sector, so they are most useful in comparing similar stocks within a sector or sub-sector.