When multiples stop working

A multiple is a ratio, and like any ratio it breaks when the denominator behaves unusually.

Negative or near-zero profit

With a loss the price-to-earnings ratio has no meaning. With profit close to zero it produces an enormous value that looks like "very expensive" and means "the denominator is almost nothing".

Such values cannot be averaged across an industry: one company distorts the median — Comparing against the sector: why absolute multiple levels are useless.

One-off items

A year with a large asset sale produces inflated profit and a deflated multiple. The security looks cheap for exactly one year — Earnings quality: how much cash is in the profit.

Negative equity

The price-to-book ratio loses meaning. That happens after large buybacks or accumulated losses.

Cyclicality

For a cyclical company the multiple is lowest at the peak of the cycle (profit is highest) and highest at the trough. Reading it literally leads to buying at the top — Economic cycles: why downturns repeat.

Industry exceptions

Banks, insurers, developers and extractive companies are valued on their own measures. No universal set exists.

What to do

Look at several measures at once, check the denominator for anomalies, and always ask what actually changed — the price or the base.

Related: P/E: what it is and why low does not mean cheap and EV/EBITDA: when it is more honest than P/E.