Definition
Multiple contraction happens when investors become less willing to pay for each dollar of earnings. This can occur due to slowing growth, rising interest rates, or increased uncertainty. A company can grow earnings but see flat or declining stock price if multiples contract enough.
Formula
Impact = (New Multiple / Old Multiple - 1) × 100%
Example
A stock earned $4 at 25x P/E ($100), then earned $5 but P/E contracted to 18x ($90). Despite 25% earnings growth, the stock fell 10% due to multiple contraction.
FAQ
What is Multiple Contraction?
When valuation multiples decrease, reducing stock prices even as earnings grow.
How do you calculate Multiple Contraction?
A common formula for Multiple Contraction is: Impact = (New Multiple / Old Multiple - 1) × 100%
Why is Multiple Contraction important?
Multiple Contraction helps investors evaluate valuation and make more informed decisions.