Calculating and Interpreting a Predicted P/E
A predicted P/E is estimated from the cross-sectional regressions of P/E on the fundamentals that are considered to determine investment value, e.g., the growth rate of earnings and payout ratio. Example: Calculating a Predicted P/E Consider a firm with…
Price Multiples Based on Forecasted Fundamentals
Justified Leading P/E Multiple based on Fundamentals $$\text{Justified leading}\ \frac{\text{P}_{0}}{\text{E}_1} =\frac{\text{D}_{1}⁄\text{E}_1}{\text{r}-\text{g}}=\frac{1-\text{b}}{\text{r}-\text{g}}$$ Where: \(1-\text{b}=\) Payout Ratio $$\begin{align*}\text{Justified leading}\ \frac{\text{P}_{0}}{\text{E}_0} &=\frac{\frac{\text{D}_{0}(1+\text{g})}{\text{E}_0}}{\text{r}-\text{g}}=\frac{(1-\text{b})(1+\text{g})}{\text{r}-\text{g}}=\bigg(\frac{1-\text{b}}{\text{r}-\text{g}}\bigg)(1+\text{g})\\ \text{Justified trailing}&=\text{Justified leading}\ \frac{\text{P}}{\text{E}}\times(1+\text{g})\end{align*}$$ If earnings are expected to grow by \(g\), next year’s earnings will be greater than last…
Fundamental Factors that Affect Alternative Price Multiples and Dividend Yield
Justified P/E Multiple Based on Fundamentals DCF valuation models can be used to estimate the justified P/E for a stock and to gain insight into the sources of valuation differences when the method of comparables is used. Connecting P/Es…
Earnings Yield
Using the P/E ratio in-stock selection involves ranking stocks from highest value to the lowest. However, ranking zero and negative P/Es would rank them below the lowest positive P/E when they are actually the most costly. A solution for…
Issues in Calculating EPS
Companies are required to disclose both basic EPS and diluted EPS. Basic EPS is the total earnings divided by the weighted average number of shares outstanding during the period. Diluted EPS reflects the effect of exercised stock options, warrants,…
Calculating and Interpreting Alternative Price Multiples
P/E Ratios Trailing P/E is calculated using the last period’s earnings as: $$\text{Trailing P⁄E}= \frac{\text{Market price per share}}{\text{EPS over previous 12 months}}$$ This is preferred when future earnings are unavailable. Leading P/E is calculated using the next period’s expected…
Alternative Price Multiples Rationales and Drawbacks
Price to Earnings Ratios There are several advantages of P/E multiples: Earnings drive the stock value. The P/E ratio is simple to calculate and widely used. According to research, differences in P/E is related to the long-run average return…
Calculating a Justified Price Multiple
A justified price multiple estimates the fair value of a price multiple that can be justified based on the method of forecasted fundamentals or the method of comparables. The justified price multiple is the value the multiple would be…
Price and Enterprise Value Multiples in Valuation
There are two methods of using price and enterprise value multiples: The method of comparables. The method based on forecasted fundamentals. The Method of Comparables The method of comparables is the valuation of an asset based on multiples of…
Stock Value Based on FCF Valuation Model
If the per-share value of equity obtained from the model is lower than the share price, the stock is overvalued. If the per-share value of equity obtained from the model is higher than the share price, the stock is…
