Fundamental analysis, which is the basis of value investing, begins with evaluating the multiples. This method allows you to find undervalued companies whose growth in value will bring fortune to a patient investor. Today we will analyze the main multipliers, their meaning and features.
✔ Multipliers – these are shown allowing you to compare business performance of different companies.
An investor note. It is necessary to compare the multipliers not so much with the index (S & P500 is the average temperature for the room), but with the industry indicators.
But it is even more important to evaluate multiples with the average of the company itself over the past 5-10 years to assess the dynamics. Long-term deterioration or improvement in performance will help assess the company’s prospects.
P / E multiplier
P / E (price / earnings) is the ratio of the company’s capitalization to its annual profit. Or the ratio of the market price of a share to net earnings per share (price / earning per share).
Besides the comparative assessment, PE shows:
- how much the investor pays for each dollar of the company’s net profit
- how many years the investment will pay off
- initial investment return
Despite its disadvantages, this is an important ratio and many investors do not exploit its full potential. Read more about the principles of working with the PE multiplier in the article: How to find promising stocks with high growth potential
PEG is the PE (price / earnings) ratio divided by future earnings growth. The ideal PEG for a promising company is less than one. The PEG formula looks simple:
PEG = Price / Earnings Per Share (EPS) / Growth
For example, the outlook for Accenture (ACN) with a PEG of 3.1 looks rather modest.
Read more about PEG in the article: Peter Lynch Method. How to find tenfolds – stocks with X10 upside potential
P / BV multiplier
P / BV (Price / Balance value) is the ratio of the market price to the asset value. It clearly shows how much the investor pays for the assets that will remain in the event of the company’s bankruptcy. The ideal P / BV multiple for an undervalued company is less than 2.
This is not the most important multiplier today. It is convenient to use for comparing banks, but it does not take into account the value of intangible assets, and therefore is not relevant for high-tech companies. It is worth mentioning the various ways of accounting for assets (manipulations) in the reports.
Multiplier P / S
P / S (Price / Sales) is the ratio of market value to revenue. Similar to PE, it shows how much the investor pays for every dollar of revenue. The main advantage of PS is that it can be calculated for all companies, including those that are not profitable.
Multiplier P / CF
P / CF (Price / Cash Flow) is the ratio of market capitalization to cash flows. This multiplier shows the company’s real money and is more informative than PE, as it is more difficult to manipulate. It is especially relevant for dividend companies, since the ability to pay dividends is assessed by free cash flow.
However, P / CF is not suitable for dealing with fast-growing companies that tend to have negative cash flows.
Is it possible to find an undervalued company today
We have analyzed the main multiples for a quick assessment of the company. Despite the fact that everyone around is trumpeting about the overheating of the market, it is quite possible to find an underestimated company today:
You can use screener sites such as finviz.com or finance.yahoo.com to quickly find companies based on specified parameters. Read more about how to use them in the article: How to look for promising US stocks for long-term investments
In the next article we will talk about specific multiples for a deeper assessment of companies (ROE, ROA, ROCE, EV / EBITDA, Piotroski F-Score, Altman Z-Score, etc.).
Yours sincerely, Vadim Orishak
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