A valuation multiple is a ratio that measures price paid per unit. The numerator is often a total value metric such as enterprise value or equity value. The denominator is some financial metric. The benefit of valuation multiples, as with any ratio, is that it expresses price in relative terms, allowing us to compare companies irrespective of size, but on the basis of how much investors are paying for each respective unit.

A simple example is Price to Earnings (P/E). This is a valuation multiple that shows how much are equity investors willing to pay for each dollar of earnings the company generates. 10x P/E, equity investors pay $10 per $1 of earnings.

The multiple can become negative when either the numerator or denominator becomes negative. We will look at cases wherein a negative financial metric (numerator) results in negative multiples.

The issue with negative multiples is that as the valuation multiple of the comps increases, say from 10x to 15x, this would suggest that the value of the firm becomes more negative. If we assume that net income is -$10, this would suggest that the value of the firm falls from -$100 to -$150. Not accurate, multiple expansion should increase the value of the company.

Ultimately, negative metrics when calculating financial metrics, EPS, and multiples can distort reality. Hence, we exclude such values from our financial models.