A multiplier is a proportional factor which measures the changes in an internal factor in response to changes in some external factors. For example, if an external factor X changes by a unit due to which an internal factor Y gets changed by M units then â€˜Mâ€™ is the multiplier.
What is Investment Multiplier?
The concept that helps to increase the aggregate income from any private or public investment refers to investment multiplier. Many students who want to learn about investment multiplying do search Earnings Multiplier Model homework solutions to get more examples to practice the whole concept.
What is Earnings Multiplier Model?
The Earnings Multiplier Model is a valuation method that is used as a medium of comparison between the current share prices of the company with its earnings per share. It is basically a ration between the two. This model is also known as the price-to-earnings ratio. The earnings per share are generally calculated on a quarterly basis. Traditionally, the calculation of EPS is concluded from the four previous quarters of the price to earnings ratio.
This model is used so that future earnings can be discounted against the money that could be invested for the same period of time at the present interest rate. It is almost like discounted cash flow where investors adjust future earnings to get the present market price. The investor thus gets determined about the current price earnings of each share to the possible future earnings. The online portals which share Earnings Multiplier Model homework solutions can provide a better definition of the model with examples.
If the current trading price per share of a company is $51 and it is earning $2.15 per share for the past 12 months,
Then the P/E for its stock would be 51/2.15 = 23.72.
What does it indicate?
The present attitude that is present in the mind of an investor is what the model indicates. The investor needs to rationalize whether the prevailing price/earnings ratio is extremely high or low based on the ratio of the market. The factors that influence the earnings multiplier should also be taken onto consideration.
Factors that affect the ratio
The basic factors that affect the ratio are â€“
- The payout ratio of expected dividends.
- The approximate rate of return on stock.
- The anticipated rate of growth of dividends.
Importance of the ratio
This ratio is a very powerful tool for investors to get a quick synopsis of the companyâ€™s financial structure without wasting time in getting into minute details. For instance, if a company A has Earnings Multiplier of 23, whereas company B has 25, then investors will obviously expect company B to have higher earnings. Students who want to master the model can search Earnings Multiplier Model homework solutions online and get more such examples.
The valuation approach
When an investor has a fair understanding of the earnings of a stock with its expected growth rate, it becomes easier to calculate the future stock prices and thus in a way helps in investing. The growth in earnings per share is calculated over few years, this helps to calculate the return over that period. The components that help to come to the final value are â€“
- The price of the final stock towards end of the stipulated time span.
- Dividends received cumulatively in that period.
- The effect of reinvestment of those dividends.
The Earnings Multiplier formula
The formula for earnings multiplier is as follows:
K â€“ G = EPS/P
The values associated are â€“
- K = the amount of risk in the company
- G = growth in earnings in future
- EPS = earnings per share expected
- P = EPS/(K-G)
Benefits of the Earnings Multiplier Model
- The most important benefit of the model is that it is very easy to be understood by anyone. The ratio does not require someone to be a master of finance to understand it. It is the simplest method to find out the value and expected growth of shares thus lessening the time to take investment decisions. Knowledge from online portals on topics like Earnings Multiplier Model homework solutions can guide anyone who is interested in the knowing the topic
- The ratio can be used be used to compare a companyâ€™s performance. If the earning per share shows growth where as the P/E ratio seems to be constant, then it is evident that there should be some miscalculation.
- The ratio is an excellent factor that can help to compare the company with the market as well as it can also compare the companyâ€™s own growth along the years.
Limitations of the Earnings Multiplier Model
- The biggest problem of this ratio is that it is subjective in nature. When the economy shows an optimistic thought, then investors overprice the shares, this can cause the prices to go so high that any fall can result in a steep drop.
- At times of recession, there could be confusion, companies can be undervalued to what it actually is.
- Negative image of a company can reflect on its stock prices. A competitor having a better brand image can overvalue their shares and the one with negative image can be affected badly.
- At times investors can consider a P/E ratio to be very high whereas someone else might consider the same to be comparatively low. This difference can in turn affect the companyâ€™s share price.
The model is the simplest way of evaluating shares. It can be used to compare a company with the industry as well as the companyâ€™s own performance over the years. At the same time we should also keep in mind that this model should never be the sole factor to determine an investment, a thorough research about all aspects related to the share should be taken into consideration before taking a decision. All of us can learn how to get this ratio, for more knowledge we can learn from online portals and search topics like the Earnings Multiplier Model homework solutions.