Getting to grips with the PE ratio: The difference between multiple expansion and multiple compression

Julie Brownlee, Fsp Invest, 02 Mar. 2015

Tags: pe ratio, multiple compression, multiple expansion, what is multiple compression, what is multiple expansion, financial ratios, investing,

One thing you may pay attention to when investing in a share is its price earnings (PE) ratio. This is a company’s current share price divided by its earnings.

It’s a way of gauging a share’s value.

A company’s PE ratio can go up and down. This is known as multiple expansion and multiple compression.

So why does this happen?

Read on to find out…

Multiple expansion explained

When you invest in a company’s shares, you want the share price to rise.

There are usually two reasons behind a share price rising:

  1. A company grows its profits.
  2. Investors are excited about a company’s growth prospects and will pay a higher multiple of its current profits.

A higher multiple means a higher PE ratio. Multiple expansion is when a PE ratio rises.

When shares and markets become more expensive, their PE multiple rises too.

The ins and outs of multiple compression

On the other hand, there is multiple compression. This is when a PE ratio falls.

When PE ratios continue to rise, there’s a higher chance of multiple compression and a higher chance of big losses.

That’s because there are less investors prepared to buy at higher prices.

There are a number of things that can lead to multiple compression. One reason is rising political tension.

Another reason is rising interest rates. When interest rates start to increase, prices of most investments fall. This means that even if a company’s managing to grow its profits, its share price can fall.

Let’s say a company has a PE ratio of 20. If you invert this (1/20) to get the earnings yield or interest rate, you get 5%.

If interest rates rise by 2%, investors now want a higher earnings yield. In our example, they’d want 7%. That means the PE ratio would dip to 14.3 times (1/7).

So there you have it, the difference between multiple expansion and multiple compression.

*********** Recommended Product ************

Your opportunity to make more than R2.8 million in less than 2 years… With only R10,000 down!

It's happened before - Now it could happen to you

In just five simple, quick-fire steps R10,000 could have made you more than R2.8 million

And to do this…

You do NOT need an MBA.

You do NOT need a lot of money.

You do NOT need a lot of time.

All you need is my little-known stock market investing secret.

Click here to find out more…


Related QA

kavesh.maharaj.73 asked:
Hi Josh Quantum wants to buy back shares from shall investors at what I think is a low price of around R3.86. You tipped the share in February [read more]
Published at 14 Mar. 2018 in: Investing Real wealth 5 answers
elizastrydom asked:
Hi Timon I am interested in registering for your Red Hot Storm Trader service. I am already a Red Hot Penny Shares investor. My question is [read more]
Published at 28 Feb. 2018 in: Investing Trading platform and broker 1 Answer
ManuE asked:
I have an interest in investing in Bitcoin, I just don't know how. If I buy Bitcoin with R15 000, how much can make (Return On Investment)? [read more]
Published at 25 Feb. 2018 in: Investing Investment 1 Answer
rickey101ter asked:
Good day gentlemen I am a subscriber of various of your products e.g. the above mentioned two and TWS, but I am not happy with the services I [read more]
Published at 07 Feb. 2018 in: Investing Investing 2 answers
bongani.zwane.127 asked:
Hi Francois, I want to invest in ETF for my kids educational funds. I would like to find out which ETF securities can I invest into for a period [read more]
Published at 01 Feb. 2018 in: Investing 1 Answer

Related articles:




Youtube Twitter Facebook

Connect with us:    

  • Accelerated Investor
  • Accessories