firmsgenerate,ortomeasuresthatarespecifictofirmsina
sector.
Earnings Multiples
Oneofthemoreintuitivewaystothinkofthevalueofany
asset is as a multiple ofthe earningsthat asset generates.
Whenbuyingastock,itiscommontolookatthepricepaid
asamultipleoftheearningspershare(EPS)generatedbythe
company. This price-earningsratio can be estimated using
currentearningsper share,yielding acurrentP/E, earnings
overthepriorfourquarters,resultinginatrailingP/E,oran
expected earnings per share in the next year,providing a
forward P/E.
Whenbuyingabusiness,asopposedtojusttheequityinthe
business,itiscommontoexaminethevalueofthefirmasa
multiple of the operating income (EBIT) or the earnings
before interest, taxes, depreciation, and amortization
(EBITDA).Although,asabuyeroftheequityorthefirm,a
lowermultipleisbetterthanahigherone,thesemultipleswill
beaffectedbythegrowthpotentialandriskofthebusiness
being acquired.
Book Value or Replacement Value Multiples
Whilefinancialmarketsprovideoneestimateofthevalueofa
business,accountantsoftenprovideaverydifferentestimate
ofvalueforthesamebusiness.Theaccountingestimateof
bookvalueisdeterminedbyaccountingrulesandisheavily
influenced by the original price paid for assets and any
accounting adjustments (such as depreciation) made since.
Investorsoftenlookattherelationshipbetweenthepricethey