When you shop for groceries or other products, you can generally spot deals or overpriced items based on comparable prices from other stores. In the stock market, investors use price multiples to gauge the relative value of a particular stock. A price multiple is a single number you can compare with price multiples of similar companies to see whether a stock might be overvalued or undervalued. There are several different multiples you can calculate. Each one is a ratio of a stock’s price to some per-share financial number, such as earnings per share, or EPS.
Visit any financial website that provides stock information. Type a company’s name or its stock’s ticker symbol into the stock quote text box and click “Get Quote.” A ticker symbol is one or more letters that are typically related to a company’s name or business.
Identify the stock’s price on the main quote page. For example, assume a stock’s price is $25.
Click “Key Statistics” or a similar link to view the stock’s important financial metrics.
Choose a per-share financial metric to use in the price multiple. Find it on the key statistics page. Common metrics include EPS, sales per share, book value per share and cash flow per share. EPS is the profit the company generated over the past 12 months for each share of stock outstanding. Sales and cash flow per share represent its per-share revenue and cash flow, respectively, over the same period. Book value is the accounting value of stockholders’ stake in the company. In this example, use sales per share, and assume the company’s is $12.
Divide the stock’s price by your chosen financial metric to determine that particular price multiple. Concluding the example, divide $25 by $12 to get a price-to-sales, or P/S, multiple of 2.08. This means investors are currently willing to pay 2.08 times the company’s “trailing-12-month” revenue to own the stock. Similarly, if you use EPS and get a “P/E” ratio of 10, the stock trades for 10 times EPS. Interpret the price-to-book value and price-to-cash flow multiples the same.
- Compare a stock’s multiple to those of its competitors and with the industry average. In general, if the multiple is less than the industry average, the stock is undervalued, or cheap, compared to its peers. A multiple that’s greater than the industry’s suggests the stock might be overvalued, or more expensive.
- An undervalued or overvalued stock isn’t necessarily a good or bad investment. Check out a company’s other financial info before picking up shares.
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