Why Multiples Matter
Discounted cash flow models are powerful but require dozens of assumptions about the future. For a quicker, comparative view of whether a share looks cheap or expensive, investors use valuation multiples — ratios that express the share price (or total enterprise value) relative to some measure of the company's financial performance. Multiples are fast, intuitive, and easy to compare across companies or time periods. They are also easy to misuse.
The Price-to-Earnings Ratio
The price-to-earnings (P/E) ratio is the most widely quoted valuation metric. It divides the share price by the company's earnings per share (EPS). A P/E of 20 means investors are paying £20 for every £1 of annual earnings — or equivalently, it would take 20 years to "earn back" the purchase price at current earnings levels.
The P/E encodes a growth expectation: companies expected to grow earnings quickly trade at high P/Es; mature, slow-growing businesses trade at low ones. This makes simple P/E comparison across companies treacherous — a low P/E may reflect a bargain or a business in structural decline.
A deeper problem is that reported earnings are an accounting construct that can be manipulated through timing decisions, depreciation choices, and one-off items. This led Robert Shiller (who received the Nobel Prize in Economics in 2013) to develop the Cyclically Adjusted P/E (CAPE), also called the Shiller P/E. It divides the current price by average inflation-adjusted earnings over the preceding ten years, smoothing out the distortions of the business cycle. Historically, high CAPE values have been associated with lower subsequent long-run returns for equity markets.
Price-to-Book Ratio
The price-to-book (P/B) ratio compares the share price to the company's book value per share — the net asset value on the balance sheet (assets minus liabilities). Benjamin Graham, the father of value investing, used P/B as a central valuation tool, seeking companies trading near or below book value as a margin of safety.
P/B is most useful for asset-heavy businesses such as banks and property companies. For technology and service businesses, where most value lies in intangible assets (brand, software, talent) that accounting rules do not fully capture on the balance sheet, P/B can be misleading — many genuinely valuable companies show extremely high P/B ratios.
EV/EBITDA
Enterprise Value (EV) is the total value of a business independent of its capital structure: market cap plus net debt. EBITDA — earnings before interest, taxes, depreciation, and amortisation — is a rough proxy for operating cash flow that strips out the effects of financing and accounting choices.
EV/EBITDA is useful precisely because it is capital-structure-neutral: you can compare a heavily indebted company with a cash-rich one on equal terms. It is widely used in mergers and acquisitions and private equity as a quick cross-company benchmark.
Price-to-Sales
For companies with no earnings — early-stage technology businesses, for instance — both P/E and EV/EBITDA are undefined. In these cases, price-to-sales (P/S) provides a denominator: the share price divided by revenue per share. It is a last resort, not a preference, because revenue is the least mature measure of profitability — a company generating huge losses can show a low P/S that looks superficially cheap.
The Danger of Multiples Without Context
The most common mistake with valuation multiples is comparing them without understanding the earnings quality underlying them. A P/E of 10 is not "cheap" if the earnings are one-off, declining, or generated by aggressive accounting. A P/E of 30 is not "expensive" if the company is compounding earnings at 25% annually with high certainty. Multiples are starting points for analysis, not substitutes for it.