1.What is a valuation multiple?

When you are trying to calculate a P/e multiple, and you divide Price per share by earning per share, what does actually mean? If you look at a lot of textbooks the answer they often give is "how valuable a company is in relation to its sales, profits, earnings and so on... For example the company has earnings of a hundred how highly is the market value based on this earnings.

However It´s means nothing by itself. It´s only meaningful in relation to the multiples of other similar companies (not necessarily public companies). It´s like saying, in real life, " the real price for that house is 500.000$, or around $500 per square foot. what does it mean? You can´t really tell what that means because it depends on the location of the house, it depends on the number the bedrooms, the neighborhood, the public school system.

Therefore, we can only say that something is expensive or cheap after comparing with other houses.

There are 2 specific points that often go overlooked with valuation multiples that I want to talk about.

1.   The companies that you are comparing should ideally have similar growth and margin profile, or the comparison will be meaningful. You should select companies in the same industry and with the same size because is useless to pick a company with 100K in sales and another one with 100 million in sales. But you also ideally want to ensure that he growth rates margin are roughly match with each other. Because if they are not, the comparison is just meaningful.

2. Even if they companies have similar financial profiles, just because the financial multiple is higher or lower it doesn´t mean that a company is overvalued or undervalued, just because a single number. There are other factors and numbers that also play a large role.  

So the way to think about this is that valuation multiples is like if you are in a detective story, and you have to figure out if the company value is appropriate or not appropriate. The valuation multiples can guide you in the right direction, but you can´t get a conclusion just seeing this multiples, so you have to be beyond it. However this is really your first step in the process.