What it is:
A price multiple is a ratio that combines some measure of a company's performance and the company's stock price.
How it works/Example:
In general, a price multiple ratio looks like this:
Price multiple = Price / Performance Metric
For example, Company XYZ has revenue of $20,000,000 per year. It has 1,000,000 shares outstanding. Today, the company’s stock price is $20 per share. Using the formula above, we can calculate Company XYZ's price-to-revenue multiple:
Revenue multiple = $20 / ($20,000,000/1,000,000) = 1.0
In Company XYZ’s industry, most companies trade at or below a 0.80 multiple, implying that Company XYZ is overvalued.
Why it matters:
There are a plethora of price multiples, but some of the most common include:
Price / EPS
Price / EBITDA per share
Price / Book value of assets per share
Price / Revenues per share
Price multiples are usually used to gain some insight about whether a company's stock price (and thus a company's value) is too high or too low.