Fundamental analysis, the basis of value investing, begins with the evaluation of multiples. This method allows us to find undervalued companies whose growth in value will make a fortune for a patient investor. Today we’ll look at the main multiples, their significance and features.
✔ Multiples are those that allow us to compare the business performance of different companies.
An investor’s note. The multiples should be compared not so much to the index (the S&P500 is the average temperature in the chamber), but to industry indicators.
But it is even more important to evaluate the multiples with the company’s own average over the past 5-10 years to assess momentum. Long-term deterioration or improvement in performance will help gauge the company’s prospects.
P/E (price/earnings) is the ratio of a company’s capitalization to its annual profit. Or the ratio of a stock’s market price to net earnings per share (price/earning per share).
In addition to comparative valuation, PE shows:
- how much an investor pays for each dollar of a company’s net income
- how many years it will take to recoup the investment
The initial return on the investment
While flawed, this is an important multiplier, and many investors do not take advantage of its full potential. Read more about the principles of working with the PE multiple in this article: How to find promising stocks with high growth potential
The PEG multiplier is the PE (price/profit) ratio divided by future earnings growth. The ideal PEG value for a promising company is less than one. The PEG formula looks simple:
PEG = Share Price (Price) / Earnings Per Share (EPS) / Growth
For example, the prospects for Accenture (ACN) with a PEG of 3.1 look rather modest.
Read more about PEG in the article: The Peter Lynch Method. How to find “tenfolds” – stocks with X10 growth potential
P/BV (Price/Balance value) is the ratio of market price to asset value. It clearly shows how much an investor pays for the assets that will remain in the event of a company’s bankruptcy. The ideal value of the P/BV multiple of an undervalued company is less than 2.
Today, this is not the most important multiplier. 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 also worth mentioning the different ways of accounting for assets (manipulation) in the statements.
P/S (Price/Sales) is the ratio of market value to revenue. Similar to PE, it shows how much an investor pays for each dollar of revenue. The main advantage of PS is that it can be calculated for all companies, including non-profitable ones.
The P/CF multiplier
P/CF (Price/Cash Flow) is the ratio of market capitalization to cash flow. This multiplier shows the company’s real money and is more informative than PE, as it is harder to manipulate. It is especially relevant for dividend companies, as free cash flow is used to evaluate the ability to pay dividends.
However, P/CF is not suitable for dealing with fast-growing companies, which tend to have negative cash flows.
Is it possible to find an undervalued company today
We’ve broken down the major multiples for quickly valuing a company. Despite the fact that everyone is trumpeting about the overheated market, it is quite realistic to find an undervalued company today.
For a quick search of companies according to the given parameters, you can use a screener site, such as finviz.com or finance.yahoo.com. Read more about how to use them in this article: How to look for promising U.S. stocks for long-term investments.
In the next article, we’ll talk about specific multiples for evaluating companies in more depth (ROE, ROA, ROCE, EV/EBITDA, Piotroski F-Score, Altman Z-Score, etc.).