2.10. Valuation: A Good Company at a Demanding Price
Lesson objective
Understand that quality and price are separate questions.
Valuation compares market price with earnings, sales, cash flow, assets, or other measures. A high multiple may reflect expectations for quality and growth. A low multiple may reflect real problems or market pessimism.
P/E relates price to earnings per share. P/S uses sales. P/FCF uses free cash flow. EV/EBITDA compares enterprise value with an operating measure before certain expenses.
There is no universally correct multiple. Compare valuation with history, peers, growth, margins, risk, and interest rates.
Valuation connects price with a business measure
P/E = Share price ÷ EPS
FCF yield = FCF ÷ Market capitalization
EV/EBITDA = Enterprise value ÷ EBITDA
Price changes the proposition
A company earns $5 per share. At $50, P/E = 10×. At $100 with earnings unchanged, P/E = 20×. The business is the same, but a new investor pays twice as much per dollar of current earnings.
Instead of only asking “Is 20× high?”, ask what growth and durability must occur for that price to produce an acceptable return.
Essential terms
| Term | Practical meaning | |---|---| | P/E | Price divided by EPS. | | P/S | Market capitalization divided by sales. | | Enterprise Value | Market Cap plus debt and certain adjustments, minus cash under the selected definition. | | FCF Yield | Free Cash Flow relative to market value. |
In Finzati
Company Snapshot includes P/E, P/S, P/B, P/FCF, EV/Sales, EV/EBITDA, Earnings Yield, and FCF Yield.
What you should remember
- A low valuation may reflect elevated risk.
- Business quality does not justify any price.
Practice
Compare P/E and FCF Yield for three similar companies and explain why the values may differ.