Compare Multiples
Relative valuation helps you understand if a stock is cheap or expensive compared to its peers or its own history.
Common Multiples
- P/E (Price-to-Earnings): Good for mature, profitable companies. Be careful with cyclical stocks.
- EV/EBITDA (Enterprise Value to EBITDA): Useful for comparing companies with different capital structures (debt levels).
- P/S (Price-to-Sales): Often used for high-growth companies that aren't yet profitable.
- P/FCF (Price-to-Free-Cash-Flow): The "truth serum" of valuation—cash matters more than accounting profits.
Triangulate Your Value
Never rely on a single multiple. A stock might look cheap on a P/E basis but expensive on a P/FCF basis if it has high capital expenditures.
The DCF Connection: Use multiples as a sanity check for your Discounted Cash Flow (DCF) analysis. If your DCF suggests a value of $100/share, but that implies a P/E of 50x when peers trade at 20x, you need to understand why.
Context is King
A "low" multiple isn't always good (it could be a "value trap"), and a "high" multiple isn't always bad (it could justify high growth). Always compare:
- vs. Peers: How does it trade relative to competitors?
- vs. History: Is it trading at the low or high end of its historical range?
- vs. Market: How does it compare to the broader S&P 500?