Introduction to Using Ratios and Multiples

Once you’ve studied the basics of stock valuation and why it is important, it’s time to get into the nitty-gritty on specific valuation methods. The most common stock valuation approach involves ratios between a stock’s market price and an element of the underlying company’s performance—earnings, sales, book value, or something similar. Ratios are very popular with investors because they can be calculated easily, and they are readily available from most financial Websites and newspapers.

While valuation ratios have become ubiquitous, it’s important to recognize their strengths and weaknesses. Valuation ratios are handy tools to have at your disposal for a quick-and-dirty analysis, but they all require a lot of context to be useful.

In this lesson, we will review the most widely used valuation ratios and discuss how to incorporate them into your thinking. Once you thoroughly understand the promises and pitfalls of valuation ratios, you can move on to more-advanced valuation methods in further studies.