STANDARDIZED VALUES AND MULTIPLES

The price of a stock is a function of both the value of the equity in a company and the number of shares outstanding in the firm. Thus, a 2-for-1 stock split that doubles the number of units will approximately halve the stock price. Since stock prices are determined by the number of units of equity in a firm, stock prices cannot be compared across different firms. To compare the values of similar firms in the market, you need to standardize the values in some way. Values for businesses can be standardized relative to the earnings generated, to the book value or replacement value of the assets employed, to the revenues generated, or to measures that are specific to firms in a sector.

Earnings Multiples

One of the more intuitive ways to think of the value of any asset is as a multiple of the earnings that asset generates. When buying a stock, it is common to look at the price paid as a multiple of the earnings per share generated by the company. The earnings per share themselves can be estimated before or after extraordinary items and can reflect what the company earned in prior periods or a furture period.