Have zero IQ about valuation techniques? No idea how to evaluate your investment options? Trying to figure out the best stocks to invest in? Here let us guide you to one of the famous method of stock valuation which would help you in making your investment decisions. We have already discussed Discounted Cash flow Method as investment valuation tool in our earlier post; let’s now focus on another widely used valuation technique, Price to Earnings ratio or multiple. Earnings multiple have always been handy when choosing a stock for investment.
Price to earnings ratio defines how much price an investor is willing to pay for $1 earning. Usually current stock price is divided by past twelve month’s earnings per share to determine trailing price to earnings multiple. However sometimes one year forward, that is next twelve month projected earnings are used to determine one year forward price to earnings multiple. Many people would wonder why this ratio is called multiple; it defines how many times investor is going to pay for the earnings from his/her investment.
This multiple is not used alone; it is a relative metrics used in reference to the company’s competitors and industry average P/E. Investor may compare the multiples of two companies belonging to the same industry or with past trend of company’s P/E. The low P/E indicates low growth in company’s earnings when compared to high P/E, which indicates high earnings growth for that company.
So for making investments in future, do consider this earning multiple to evaluate your investment options.
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