{"id":1986,"date":"2019-09-27T13:33:00","date_gmt":"2019-09-27T13:33:00","guid":{"rendered":"https:\/\/analystprep.com\/cfa-level-1-exam\/?p=1986"},"modified":"2026-03-11T15:48:11","modified_gmt":"2026-03-11T15:48:11","slug":"using-price-multiples-value-equity","status":"publish","type":"post","link":"https:\/\/analystprep.com\/cfa-level-1-exam\/equity\/using-price-multiples-value-equity\/","title":{"rendered":"Using Price Multiples to Value Equity"},"content":{"rendered":"\n<script type=\"application\/ld+json\">\n{\n  \"@context\": \"https:\/\/schema.org\",\n  \"@type\": \"VideoObject\",\n  \"name\": \"Equity Valuation: Concepts and Basic Tools (2025 Level I CFA\u00ae Exam \u2013 Equity \u2013 Module 8)\",\n  \"description\": \"CFA Level I Equity lesson on Equity Valuation covering intrinsic value, dividend discount models (constant growth and multistage), free cash flow to equity (FCFE), preferred stock valuation, price multiples (P\/E, P\/B, P\/S, EV multiples), asset-based valuation models, and determining whether a stock is overvalued or undervalued.\",\n  \"thumbnailUrl\": \"https:\/\/img.youtube.com\/vi\/GWw4je023oo\/maxresdefault.jpg\",\n  \"uploadDate\": \"2023-07-27\",\n  \"duration\": \"PT53M43S\",\n  \"contentUrl\": \"https:\/\/www.youtube.com\/watch?v=GWw4je023oo\",\n  \"embedUrl\": \"https:\/\/www.youtube.com\/embed\/GWw4je023oo\"\n}\n<\/script>\n\n<script type=\"application\/ld+json\">\n{\n  \"@context\": \"https:\/\/schema.org\",\n  \"@type\": \"QAPage\",\n  \"@id\": \"https:\/\/analystprep.com\/cfa-level-1-exam\/equity\/using-price-multiples-value-equity\/#qapage-question-1\",\n  \"mainEntity\": {\n    \"@type\": \"Question\",\n    \"@id\": \"https:\/\/analystprep.com\/cfa-level-1-exam\/equity\/using-price-multiples-value-equity\/#question-1\",\n    \"name\": \"Which factor, when decreased, will increase the justified forward P\/E multiple?\",\n    \"text\": \"All else equal, a decrease in which of the following will cause an increase in the justified forward P\/E multiple?\\nA. Growth rate.\\nB. Payout ratio.\\nC. Required rate of return.\",\n    \"answerCount\": 1,\n    \"author\": {\n      \"@type\": \"Organization\",\n      \"name\": \"AnalystPrep\"\n    },\n    \"acceptedAnswer\": {\n      \"@type\": \"Answer\",\n      \"@id\": \"https:\/\/analystprep.com\/cfa-level-1-exam\/equity\/using-price-multiples-value-equity\/#answer-1\",\n      \"text\": \"C. Required rate of return. There is an inverse relationship between the required rate of return and the justified forward P\/E multiple, so a decrease in the required return leads to a higher justified forward P\/E.\",\n      \"author\": {\n        \"@type\": \"Organization\",\n        \"name\": \"AnalystPrep\"\n      }\n    }\n  }\n}\n<\/script>\n\n\n<p><iframe loading=\"lazy\" src=\"\/\/www.youtube.com\/embed\/GWw4je023oo\" width=\"611\" height=\"343\" allowfullscreen=\"allowfullscreen\"><\/iframe><\/p>\n<p>The use of price multipliers to earnings, book value, and sales have all shown to have significant predictive value in determining relative future returns, implying that price multiples can be an effective tool for the valuation of companies. In addition, calculating the \u201cjustified value\u201d (the value justified by fundamentals or a set of cash flow predictions) of certain multiples offers an alternative way of estimating intrinsic value.<\/p>\n<p><a style=\"display: block; margin: 20px 0 28px; padding: 14px 18px; border: 2px solid #2563eb; border-radius: 12px; text-align: center; color: #2563eb; text-decoration: none; font-weight: 500; font-size: 15px; background-color: #ffffff;\" href=\"https:\/\/analystprep.com\/free-trial\/\" target=\"_blank\" rel=\"noopener noreferrer\"> Practice price multiple valuation questions. <\/a><\/p>\n<h2><strong>Justified Price\/Earnings Multiple<\/strong><\/h2>\n<p>Assuming a constant rate of growth, the justified forward price-to-earnings ratio can be found using the following equation:<\/p>\n<p>$$ \\frac{P_0}{E_1}= \\text{justified forward P\/E}$$<\/p>\n<p>$$ \\frac{P_0}{E_1}=\\frac{p}{r-g}$$<\/p>\n<p><em>p<\/em> = payout ratio<\/p>\n<p><em>r<\/em> = required rate of return<\/p>\n<p><em>g<\/em> = expected growth rate of dividends<\/p>\n<p>The justified forward P\/E is inversely related to the required rate of return and positively related to the growth rate. However, this relationship may not be true because a higher payout ratio may imply a slower growth rate due to the company retaining a lower proportion of earnings for reinvestment. These estimates may be highly sensitive to small changes in assumptions, so it may be useful to conduct a sensitivity analysis.<\/p>\n<h2><strong>The Method of Comparables<\/strong><\/h2>\n<p>The economic rationale underlying the method of comparables is the law of one price: identical assets should sell for the same price. Thus, if an appropriate benchmark multiplier representative of a peer group or industry can be set, an analyst can determine the current relative value of a given company.<\/p>\n<p>However, it is not always easy to determine comparable companies or industries due to other business lines and differing company sizes. For instance, it would be relatively hard to find a comparable company to Apple \u2013 one that sells over 200 million smartphones per year and millions of computers and tablets throughout the world.<\/p>\n<blockquote>\n<h3><strong>Question<\/strong><\/h3>\n<p>All else equal, a decrease in which of the following will cause an increase in the justified forward P\/E multiple?<\/p>\n<ol style=\"list-style-type: upper-alpha;\">\n<li data-tadv-p=\"keep\">Growth rate.<\/li>\n<li data-tadv-p=\"keep\">Payout ratio.<\/li>\n<li data-tadv-p=\"keep\">Required rate of return.<\/li>\n<\/ol>\n<p><strong>Solution<\/strong><\/p>\n<p>The correct answer is <strong>C<\/strong>.<\/p>\n<p>Due to the inverse relationship between the required rate of return and the justified P\/E, a decrease in the required return will justify a higher forward P\/E. This should make sense intuitively since investors are willing to pay a higher price for assets as they relax their return requirements.<\/p>\n<\/blockquote>\n\n\n<div style=\"text-align:center;margin:50px 0 30px;\">\n\n  <a href=\"https:\/\/analystprep.com\/free-trial\/\"\n     target=\"_blank\"\n     rel=\"noopener noreferrer\"\n     style=\"\n       display:inline-block;\n       padding:14px 34px;\n       background:linear-gradient(135deg,#4a74d1,#3b66c4);\n       color:#ffffff;\n       font-size:18px;\n       font-weight:600;\n       text-decoration:none;\n       border-radius:50px;\n       box-shadow:0 6px 18px rgba(59,102,196,0.25);\n     \">\n     Start Free Trial\n  <\/a>\n\n  <p style=\"\n       margin:18px auto 0;\n       max-width:620px;\n       font-size:16px;\n       line-height:1.6;\n       color:#333333;\n     \">\n     Strengthen your understanding of equity valuation using price multiples with CFA Level I exam-style practice questions.\n  <\/p>\n\n<\/div>\n","protected":false},"excerpt":{"rendered":"<p>The use of price multipliers to earnings, book value, and sales have all shown to have significant predictive value in determining relative future returns, implying that price multiples can be an effective tool for the valuation of companies. In addition,&#8230;<\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":""},"categories":[8],"tags":[],"class_list":["post-1986","post","type-post","status-publish","format-standard","hentry","category-equity","blog-post","no-post-thumbnail","animate"],"acf":[],"yoast_head":"<!-- This site is optimized with the Yoast SEO plugin v26.9 - https:\/\/yoast.com\/product\/yoast-seo-wordpress\/ -->\n<title>Price Multiples for Equity Valuation | CFA Level 1<\/title>\n<meta name=\"description\" content=\"Learn how price multiples, including justified P\/E ratios, help assess equity value and predict relative future returns in CFA Level 1 valuation.\" \/>\n<meta name=\"robots\" content=\"index, follow, max-snippet:-1, max-image-preview:large, max-video-preview:-1\" \/>\n<link rel=\"canonical\" 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