How and why do we select a “Preferred Multiple” for a stock?

 

Selection of the Preferred Multiple

In order to conduct relative valuation, we need to first decide on an appropriate valuation ratio for a company, to then compare it to other companies. This is because not every valuation ratio is relevant to every company. Keep in mind this section does not contribute to the snowflake score as it is just an overview and no analysis is conducted yet. 



Here you can see we have three primary ratios that we consider: Price-to-Earnings, Price-to-Sales and Price-To-Book. Each ratio indicates how much you would be paying today per dollar of earnings, sales or book value, respectively. You can find out more details of each ratio and what it means by hovering over the tooltip for each.

To decide on which ratio is most appropriate for the stock we’re looking at, we use an algorithm to select the most appropriate ratio. You’ll know which ratio has been selected because it will be the first displayed here, and the words “Key Metric” will be displayed in blue in that ratio’s tooltip. 

If a company is profitable, we’ll use the Price-to-Earnings ratio. However, if a company is not yet profitable, we’ll use the Price-To-Sales ratio.

These ratios tell you how much investors are willing to pay for each dollar of Earnings or Sales. It is also worth noting that high expected growth can sometimes justify higher valuation multiples.

In some cases, like if the stock is a financial institution, such as a bank, or it doesn’t meet our P/E or P/S criteria, we’ll use the Price-To-Book ratio since it's a business that primarily generates income from its balance sheet.  

If you’d like to see more details of the selection process, you can view our help centre article which will be linked down below.

We use this Key Valuation metric to compare the company to its peers, its industry and to the Fair Ratio that we calculate in sections 1.2, 1.3 and 1.4 below.

For more information about these ratios, you can check out the learn modals on the platform, or the articles on our help centre.   

 

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