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Multiple Compression

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Multiple Compression
The effect that arises when a stock trades at a certain multiple and, while Earnings may be good, the stock price doesn't move or sometimes goes down.
    
The result is that the given multiple is reduced even though nothing is fundamentally wrong with the company. The Valuation has been called into question and the multiple you are willing to pay for that stock is the only thing different.
    
Remember, the multiple is based off of many factors, but most importantly the Future expectations of a company. If a company trades at say, a P/E multiple of 50, this means investors are paying $50 for each $1 of Earnings. Generally, an investor would only pay such a High multiple on the expectation that the company Will grow significantly faster than its competitors or the stock market in general.
    
When the company's growth rates start to slow, investors might start to doubt its growth prospects, and thus not pay an expensive a Premium as they once did. In our case, the company might experience multiple compression with the P/E shrinking to 25, even though Earnings haven't changed. With the same Earnings of $1, this would mean that the stock price fell in half (25/50 = 1/2). This demonstrates how the stock price could go down when Earnings stay the same.
Posted by  marcus evans (Europe) Ltd
 
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