rerating

Rerating refers to a shift in the market’s valuation of a company, security, or asset that results in a different price ascribed to its cash flows or earnings, independent of a proportional change in fundamentals. In equity markets, it often describes a change in valuation multiples such as price-to-earnings (P/E) or enterprise value to EBITDA (EV/EBITDA), driven by altered growth prospects, profitability, risk, or capital structure. Rerating can be positive (multiple expansion) or negative (multiple contraction).

Causes and drivers include improvements or deteriorations in growth prospects, margins, return on invested capital, and capital allocation efficiency. External factors such as interest rates, inflation, macroeconomic conditions, and sector-specific regulatory or technological changes can also prompt rerating. Market sentiment and changes in consensus earnings estimates frequently accompany or reinforce rerating.

Mechanics and measurement: A company’s price change may reflect a higher multiple applied to similar cash flows, or a lower discount rate from improved risk perception, even if reported earnings remain steady. Analysts monitor shifts in multiples relative to peers, historical norms, or market indices, and may infer implied growth or risk changes from price movements.

Types and implications: Positive rerating leads to higher valuation multiples and potentially outsized gains if fundamentals improve. Negative rerating results in lower multiples and potential price declines. Rerating can be sector-wide or company-specific, and may be temporary or persistent.

Limitations: Rerating is influenced by market sentiment and liquidity and may not coincide with underlying fundamentals, making valuations vulnerable to reversals if expectations adjust. Related concepts include multiple expansion, earnings revisions, and relative valuation.