Valuation and Ratios
14 articles · 15 glossary terms
The arithmetic that turns a statement into a comparison: multiples, margins, returns on capital, and what each one hides.
Foundations
Start here if the subject is new.The Price-to-Earnings Ratio
The most quoted number in equities, and the most misread. It compares price to one year of profit and says nothing at all about the years after it.
Dividends: Yield, Payout and Safety
A dividend is a discretionary distribution. The yield is trivially calculated and the interesting question is always whether the company can keep paying it.
Gross, Operating and Net Margin
Margins convert absolute profit into a rate, which is what makes companies of different sizes comparable. Each of the three answers a different question.
Intermediate
Assumes the foundations above.The PEG Ratio
An attempt to price growth alongside profit by dividing the P/E by a growth rate. Useful as a rough sort, fragile as a valuation.
Price-to-Sales and Price-to-Book
Two multiples that work where earnings do not: one anchored to revenue, the other to the balance sheet. Each is useful in a narrow set of situations and misleading outside it.
Enterprise Value and EV/EBITDA
Market cap prices the equity; enterprise value prices the whole business. Comparing companies with different debt loads requires the second one.
Valuing Against a Peer Set
A multiple only means something next to something else. Choosing what that something else is does most of the analytical work.
EV to Sales
Enterprise value divided by revenue. The multiple used where there are no profits, and the one that requires the strongest assumption to interpret.
Free Cash Flow Yield
Free cash flow divided by market value, expressed as a percentage. Harder to manipulate than an earnings yield and noisier than one.
Advanced
Detail, edge cases and methodology.Return on Equity, Assets and Invested Capital
Profit means little without knowing how much capital was needed to produce it. These ratios answer that, and the differences between them are mostly about leverage.
Discounted Cash Flow, in Plain English
The theory every multiple is a shortcut for: a business is worth the cash it will produce, discounted for the fact that future cash is worth less than cash today.
Sum of the Parts
Valuing each business within a company separately and adding them up. Useful where the parts deserve different multiples, and dependent on disclosure that may not exist.
Residual Income
Valuing a company as its book value plus the present value of the profit it earns above its cost of capital. It puts the return-against-cost comparison at the center.
Scenario and Sensitivity Analysis
Varying the inputs to see how much the answer moves. It converts a point estimate into a range and identifies which assumption is actually carrying the conclusion.
Terms Defined in This Subject
Open one for its definition, and the article that explains it in full.
Frequently Asked Questions
What does the P/E ratio tell you?
The price-to-earnings ratio is the share price divided by earnings per share: what the market is paying for each dollar of annual profit. A high P/E means the price assumes earnings will grow or stay durable; a low one means it assumes less. On its own it says nothing about whether either assumption is right.
Read the full article: The Price-to-Earnings RatioWhat is enterprise value?
Enterprise value is the market value of a company's equity plus its debt, minus its cash. It approximates what it would cost to buy the whole business, including taking on what it owes, which makes ratios such as EV/EBITDA comparable between companies financed in very different ways.
Read the full article: Enterprise Value and EV/EBITDAWhat is a discounted cash flow valuation?
A discounted cash flow valuation estimates a business's worth today by projecting the cash it will generate and discounting each year back at a rate that reflects risk and time. The method is sound; the result is only as reliable as the growth, margin and discount rate assumptions fed into it, and small changes move it a lot.
Read the full article: Discounted Cash Flow, in Plain English