Multiple Compression
Categories: Company Valuation
Your company, CancerBeGone, made a drug that was believed to be able to cure liver cancer. It sold drugs for 10 bucks a pill and, for the most part, miraculously, it worked. It traded at 100 times forward earnings. For a while.
But then, after 5 years of ingestion, it turned out that the people taking the drug turned into zombies. Zombies who didn't love football. White Walkers.
So nobody wanted to take the drug anymore, and the stock of CancerBeGone not only suffered a decline in earnings, but also a decline in the multiple of earnings at which it traded.
CancerBeGone suffered multiple compression. Instead of earning a dollar a share and trading at $100 a share, it only earned 30 cents a share and traded at only 10 times that earnings number, or $3 a share.
Big multiple compression: a fate worse than zombies addicted to curling.