Earnings Multiplier is perhaps the most analyzed and handy tool to assess the value of a company or business under consideration for the sale, acquire or partnership. The owner also can take a look into how his company has grown in terms of cash flow through the years since it helps to compare the current market price of a stock with respect to earnings per share over the different time periods. It also demonstrates the position of the company in comparison to its counterparts or competitors.
Both the seller and the buyer can take fruits out of the basket by business valuation. While the buyer gets a chance to financially and logically examine the consequences of buying the business under consideration. The seller can utilize this detailed report to study the operation of his business, how it has transformed over the years and if he can change any negative plunges instead of handing it over completely to another owner.
A simple example to illustrate the tool
You have a company manufacturing textiles which you inherited from your father. The company had gone public when your father was the owner and was priced at $30 per share. The company then had earnings of $10 per share. The earnings multiplier is $30/$10 per year = 3 years, which implies that the company would have taken 3 years to get back the stock price of $30 and is running at 3 times earnings.
The current market price of each share of your company is $100 and the income is $20 per share. Then the current P/E ratio of your business is $100/$20, which is 8, that is, currently your business is running at 8 times the earnings. A comparison of P/E ratio for the two generations gives you the difference in the production efficiency of your business. Since business valuation analyzes almost all aspects of an operating business, it is convenient to know the faults and areas for improvement. This example shows that the current price is more expensive than the former calculation 3 years ago and will be less attractive to a new owner or the acquiring company.
In a second case, you can compare the asset worth of your business with other companies working in the same genre and with the same classification. Another textile manufacturing company has a current stock price of $100 and earnings per share of $10, giving a P/E ratio or multiplier of 10 years. This means that the second company is more expensive than your company and lesser chances of getting preferred by a buyer or partner.