Multiples Matter: How Earnings Multiples Drive Stock Prices

When it comes to investing, understanding the relationship between earnings multiples and stock prices is crucial. Earnings multiples, such as the Price-to-Earnings (P/E) ratio, help investors evaluate a company's valuation and make informed decisions. In this article, we'll explore how earnings multiples influence earnings and affect stock prices, using real-world examples to illustrate these concepts.



1. Price-to-Earnings (P/E) Ratio: The P/E ratio is the most commonly used earnings multiple, comparing a company's stock price to its earnings per share (EPS). A high P/E ratio suggests that investors are willing to pay more for each dollar of earnings, indicating high growth expectations or overvaluation. Conversely, a low P/E ratio might suggest undervaluation or slow growth.

For instance, consider Apple (AAPL) and Tesla (TSLA). As of February 2025, Apple had a P/E ratio of around 30, reflecting investors' confidence in its stable earnings and growth potential. In contrast, Tesla's P/E ratio was over 50, indicating investors' high expectations for its future growth. However, if Tesla's earnings growth fails to meet expectations, its stock price could be vulnerable to significant declines.

2. Enterprise Value-to-EBITDA (EV/EBITDA): EV/EBITDA compares a company's enterprise value (market capitalization plus debt) to its earnings before interest, taxes, depreciation, and amortization (EBITDA). This multiple is useful for comparing companies with different capital structures or those with significant depreciation expenses. A high EV/EBITDA might indicate overvaluation, while a low EV/EBITDA could suggest undervaluation.

For example, let's examine TSMC (TSMC) and NVIDIA (NVDA). As a leading semiconductor manufacturer, TSMC had an EV/EBITDA ratio of around 20 in February 2025, indicating a stable valuation compared to high-growth tech firms. In contrast, NVIDIA's EV/EBITDA ratio was over 60, reflecting investors' high expectations for its AI and data center business growth.

3. Price-to-Sales (P/S) Ratio: The P/S ratio compares a company's stock price to its sales per share. This multiple is useful for companies with high growth potential but low or negative earnings, such as startups or turnaround situations. A high P/S ratio might indicate overvaluation, while a low P/S ratio could suggest undervaluation.

Consider Amazon (AMZN) and Pets.com. In the late 1990s, Pets.com had a high P/S ratio, reflecting investors' enthusiasm for its business model. However, when the dot-com bubble burst, Pets.com's stock price collapsed, and the company eventually went bankrupt. In contrast, Amazon's P/S ratio remained relatively high, but its strong execution and growth prospects allowed it to weather the storm and emerge as a dominant player in the e-commerce space.

In conclusion, earnings multiples play a crucial role in understanding a company's valuation and making informed investment decisions. By analyzing earnings multiples such as P/E, EV/EBITDA, and P/S, investors can gain valuable insights into a company's earnings and stock price dynamics. However, it's essential to consider multiple factors and use a combination of valuation methods to make well-rounded investment decisions.