Good Companies Bad Multiples

Topics: Financial ratio, P/E ratio, Fundamental analysis Pages: 3 (986 words) Published: September 14, 2013
Article Outline – Why Bad Multiples Happen to Good Companies
The article suggests that rather than focusing too much on having the highest multiples with regards to the companies’ performance, managers and executives will be better off focusing on the amount of value they create with regards to growth margins and capital productivity. One example of this was the US household-products manufacturer Church & Dwight, although the company’s growths on EBITA margins (+13.9% points compared to the +2.5% points for the median company in the sector) and TRS (total returns to shareholders – which was higher than the sector and the S&P 500) were very impressive, the less ‘crucial’ earnings multiple fell from 16 to 10. Part of it was because their multiples had been high at the outset, and also the low earnings at the start, and those ratios soon gravitated towards the median for the sector after a few years. This also shows that the multiples comparison is not as important and critically determining as it was originally thought to be. Low earnings multiples on a company do not necessarily mean that it is performing badly compared to its peers.

Unfortunately, there are too many executives, managers, and even less ‘sophisticated’ investors worrying too much over multiples such as the P/E ratio. There are a number of problems with simply comparing a company’s multiples, particularly the price-to-earnings (P/E) ratio, with the peers: * If a company’s P/E seems too low, it might be because those executives were comparing their company with the wrong set of peers – in one case they were comparing with the faster-growing segment of the market than their own. Analysis of investors who are evaluating companies based on what they are and not what they aspire to be (projections of future growth and profitability) is flawed. If they wish to perform a more relevant comparison for the purpose of multiples analysis, then they should look into companies that compete in the...
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