Lesson 6 of 7 · 14 min
Price multiples and the method of comparables
A price multiple compares a share's price with a per-share fundamental; you can judge it against fundamentals (the justified P/E from the Gordon model) or against similar companies (the method of comparables).
In short
- Main multiples: P/E, P/B, P/S and P/CF (cash flow = operating or free cash flow).
- Trailing multiples use past values; forward (leading) multiples use forecasts. Use the same basis for every company compared.
- Justified forward P/E from the Gordon model: , where p = payout ratio.
- P/E rises with g, falls with r. A higher payout need not raise P/E, because it can lower growth (dividend displacement of earnings).
- Method of comparables rests on the law of one price: benchmark a multiple against a close peer, the industry average or median, or the company's own history.
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