Stock Multiples: How to Tell When a Stock is Cheap/Expensive

You want to invest in

stock

s but have no idea if now is a good time to buy. You've probably heard the old saying about buying low and selling high, but what does that really mean? When is the

stock

price considered low? $10 per share. $100 there is no perfect answer to these questions, but there are ways to at least measure how

expensive

or how successful the stock is. Using something called a multiple, we can calculate how much we are paying for the shares underlying the business and whether this price has changed. Over time, if we are interested, we will delve deeper into the topic and more about today's simple bagel.

You may have noticed that

when

you Google a stock like Google, for example, you end up with a series of search results, as well as some basic details about the ticker. It has its stock, open price, market cap, and dividend yield there, but it also lists something called the company's p/e ratio. The p/e is an example of what is called a multiple ratio that compares the price of a stock to some general fundamental number. Speaking, the higher the multiple, the more

expensive

a stock is considered, think that, like the price per pound in a butcher shop,

when

buying pork or chicken, it is difficult to compare the total prices since the quantity you get is different for each cut, but if you look at the price per pound, you can easily determine which cut is the best bang for your buck.

Multiples work in a similar way, allowing us to compare the price of a stock to the underlying fundamentals you are getting from purchasing. There are now hundreds of different

multiples

that investors can use, including evie price to one bita to establish book value, etc., some of the

multiples

are industry specific, while others are broader in nature and each It has a different implication, but the P/E ratio represents the price. The profit ratio is one of the simplest and most popular; It's fairly easy to calculate as you take the share price and divide it by the company's earnings per share, for example if Plain Bagel Co had 1 million shares outstanding, each of which we are trading. price of $30 and last year its net income was 2 million dollars the p/e ratio of the stock would be 15 times this p/e ratio is known as trailing p/e because we are calculating it using historical information and it is one One of the easiest multiples to understand basically represents how much an investor is willing to pay for each dollar of the company's earnings, so for Plain Bagel Co we are paying a price equal to 15 times our share of the company's earnings, So the trailing P/E helps conceptualize how much we pay for a stock, but it has its flaws, the biggest of which is that it looks backward, while many believe markets look forward if a company is expected to launch a new product, enter a new market or improve your operations.

In the future, a stock is likely to trade higher, something you wouldn't account for using past earnings to explain the current Sox price. Because of this, many investors prefer to use what is known as a forward multiple, in this case the forward. p/e which divides the price of a stock by how much the company is expected to earn next year, for example, say Plain Bagel Co is expected to launch a new bagel product next year and as a result, analysts expect that profits increase to 2.5 million. dollars next year, in this case, assuming everything else remains unchanged, the forward p/e multiple of simple bagel COEs would be 12 times now, the clear problem with multiples is that they are based on forecasts that may not be successful, but they can still help measure the value of a stock and how much investors are paying for a company's potential profit, so for a mega gaming code, our forward P/E is 12 times higher, but what does that mean?

Well, on its own, it's not much. Multiples are a relative measurement, sure, we understand how. How long it will take for your stock to pay for itself is useful, but to understand whether the level is attractive or not, we have to compare it to other multiples. We could, for example, compare the P/E ratio to historical simple bagel COEs p/. The ratios to see how it has changed over time will give us an idea of ​​whether investors are valuing the company above normal. If the company's earnings are expected to rise but the share price has fallen, it would mean that the multiple has changed. it contracted and investors do not value the company's profitability as much as before;

Alternatively, if earnings are falling but prices are up a lot, the multiple has expanded, meaning people are paying more for less earnings, we could also compare the P/E multiple to the stock's long-term average for see if the spread is higher or lower than normal If the stock's ten-year average p/e is 15 times, for example, we can assume that the stock's multiple is temporarily

cheap

er than normal and we can warn you to buy If we take the stock at the multiple then it expands back to its long-term average, then we could get a return even if that company's earnings are flat.

A key assumption here is that a multiple is expected to return to its mean over time and as long as that does not happen. Not always true, investors sometimes look for extreme variations from the mean and many believe that small short-term volatility in stocks, which could be caused by a bad press release or a short-term negative headwind, will eventually will decline and cause the multiple to return to its normal level, assuming a company's core business remains unchanged, that's great, so if I find a company trading at multiples below its historical average, I can buy well, Well, I'm not quite sure I understand where the company's stock value stands in relation to its past is great. but you should also compare the value to other stocks in the same industry in our analogy, if you found pork on sale for $6 a pound, it may still be too expensive if a closer butcher offers pork at a normal price of $2.50. a pound similarly if we need to measure the value of a stock relative to its peers, so let's take simple Bagel Co and compare it to Sesame Sands and Hangul Bagel, which trade at PEs of 13 and 7 times , respectively, if you compare the simple one. bagel COE 12 times multiple of its average dock of 10 times well, then we can see that the stock is actually more expensive than other bagel companies on average, so the stock is

cheap

er than normal but more expensive than its peers, so should you buy or sell or how good it would be to have a single number basis for making investment decisions, it's just not that simple multiples are limited in the amount of information they provide with a P/E multiple, e.g. we are taking into account the The company's growth rate is safe compared to its peers COE of simple bagel p/e of 12 times may seem expensive, but a Bagel Co is also growing its earnings at a faster rate, the multiple may be justified, this is why high-growth companies like those in the tech space tend to have higher multiples than stocks and slower-moving areas, like utilities, on the other side of the spectrum.

Just because a company is trading at a price below its peers or even below its historical average does not mean it is a good buy, multiple compression could be justified if the company's fundamentals have deteriorated, what do I mean with that? Well, let's go back to our analogy, imagine you are at the butcher shop and you see two steaks trading at $10 a pound and $3 a pound looking for some value of your choice. You up the $3 cut, but when you get home you discover that the steak you bought is expired and that it's a lower quality cut, you're not even sure if it's actually beef, so besides knowing that there's probably some problem with the three dollar steak.

What is the lesson here? Well, just because something is cheap doesn't mean you should buy it. A lower stock price-earnings ratio may reflect a justified devaluation of the company, perhaps for the simple bagel. Ketogenic diets are expected to take down the bagel industry or perhaps companies facing regulations that will prevent them from making their basic plain bagel, these are things that would hurt the future profitability of plain bagel COEs and while the multiple would contract , does not constitute the company and goodbye because the company's core long-term prospects have deteriorated. The thing about multiples is that they are meaningless without context and chasing low multiples without understanding a company's core business and future prospects can leave you with something called a value trap, a stock that looks cheap compared to its historic crisis but that continues to fall even.

Furthermore, with the company's fundamentals deteriorating, then why talk about multiples if they could mean that a stock is overvalued or undervalued? Well, it's not that multiples are useless, they are a handy way to quickly understand the price level of a stock, but as I said in the beginning, they are a rough indicator of a stock's value, at best, Some investors even question that the P/E multiple is incredibly limited due to its use of accounting earnings figures that can be easily altered by management assumptions and non-monetary items, so while multiples can certainly help you make investment decisions.

We need to ensure that your decision is based on a deep understanding of a company's operations and its future prospects, not just multiple actions. A good approach is to find companies you like based on their fundamentals and then find a few. appropriate multiple to understand the company's valuation after the fact, look for cheap stocks first, mainly, have a portfolio of low quality holdings, after all, since Warren Buffett says that it is much better to buy a wonderful company at a fair price than a fair company at a wonderful price. So the next time you find a stock trading at a low multiple or a share selling for three dollars a pound, be sure to check the fundamentals and expiration bets and that the steak is actually a steak, but that being said, it is We're running out of time if If you like this video, hit the like button and if you like what we're doing here, subscribe, hit the bell icon to make sure you get notified about future videos.

If you have any comments or topics you would like us to cover in future videos, please leave. a comment below for the plain bagel. My name is Richard Coffin. Thank you for joining me today.