 # 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 earnings as:

$$\text{Leading P⁄E}= \frac{\text{Market price per share}}{\text{Forecasted EPS over next 12 months}}$$

This is preferred when trailing earnings do not reflect the future.

#### Example: Calculating P/E Ratio

Consider the following information

• Earnings = $50 million • Forecasted EPS over the next 12 months =$1.2
• Number of outstanding shares = 80 million
• Market price = 20.00 per share Trailing and leading P/E ratios are closest to: #### Solution \begin{align*}\text{Current year EPS} &= \frac{50}{80} = \0.625\\\text{Trailing P/E} &= \frac{\20}{\0.625} =32\\ \text{Leading P/E}&=\frac{\20}{\1.2}=16.67\end{align*} ## Price to Book Value Ratios Price to book value is calculated as: $$\text{P⁄B ratio}=\frac{\text{Market value of common shareholders’ equity}}{\text{Book value of common shareholdes’ equity}}$$ \begin{align*}\text{Book value of common shareholders’ equity}&=\text{Shareholders’ equity}-\text{Total value of equity claims senior to common stock}\\ \\ \text{Book value per share}&= \frac{\text{Common shareholders’ equity}}{\text{Number of common stock shares outstanding}}\\ \\ \text{Market value of common shareholders’ equity}&=\text{Share price}\times\text{Shares outstanding}\end{align*} This ratio can also be calculated on a per-share basis by dividing both the numerator and denominator by the number of shares outstanding. #### Example: P/B Ratio Consider the following information: • Current share market price =15
• Shares outstanding = 100,000
• Cash flow from operations = 600,000 • Shares outstanding = 100,000 P/CF ratio can be calculated as: #### Solution \begin{align*}\text{P⁄CF}&= \frac{\text{Market price per share}}{\text{Free cash flow per share}}\\ \\ \text{Free cash flow per share}&= \frac{\600,000}{100,000}=\6.00\\ \\ \text{P⁄CF}&= \frac{\15}{\6}=2.5\end{align*} When comparing the P/CF ratios of different companies, the company with the lower P/CF ratio is relatively undervalued. ## Dividend Yield The dividend yield is computed as dividend per share divided by the stock price. There are two types: i. Trailing dividend yield, calculated as: $$\text{Trailing dividend yield}= \frac{\text{Most recent yearly dividend}}{\text{Current market share price}}$$ ii. Leading dividend yield, calculated as: $$\text{Leading dividend yield}=\frac{\text{Next year’s forecasted dividend}}{\text{Current market price}}$$ #### Example: Dividend Yield Consider the following information: • Current market price =29.00
• Dividends paid in the last four quarters:
• Q2: 2020 = $0.52 • Q3: 2020 =$0.55
• Q4: 2020 = $0.56 • Q1: 2021 =$0.56
• Next year’s dividend is forecasted to be 2.28. The trailing dividend yield can be calculated as: #### Solution \begin{align*}\text{Trailing dividend yield}&=\frac{\text{Most recent yearly dividend}}{\text{Current market share price}}\\&=\frac{(0.52+0.55+0.56+0.56)}{29}\\&=0.07552≅7.55\%\end{align*} The leading dividend yield can be calculated as: \begin{align*}\text{Leading dividend yield}&=\frac{\text{Next year’s forecasted dividend}}{\text{Current market price}}\\&=\frac{2.28}{29}\\&=0.0786≅7.86\%\end{align*} ## Question Consider the following information: • Expected EPS in the first quarter = 0.30 • Expected EPS in the second quarter = 0.37 • Expected EPS in the third quarter = 0.43 • Expected EPS in the fourth quarter = 0.48 • Current price =28.00

The forward P/E ratio is closest to:

1. 14.58.
2. 17.72.
3. 23. 33.

### Solution

$$\text{Forward P⁄E ratio}= \frac{28.00}{(0.30+0.37+0.43+0.48)}=17.72$$

Reading 25: Market-Based Valuation: Price and Enterprise Value Multiples

LOS 25 (d) Calculate and interpret alternative price multiples and dividend yield.

Shop CFA® Exam Prep

Offered by AnalystPrep Level I
Level II
Level III
All Three Levels
Featured Shop FRM® Exam Prep FRM Part I
FRM Part II
FRM Part I & Part II
Learn with Us

Subscribe to our newsletter and keep up with the latest and greatest tips for success
Shop Actuarial Exams Prep Exam P (Probability)
Exam FM (Financial Mathematics)
Exams P & FM GMAT® Complete Course Daniel Glyn
2021-03-24
I have finished my FRM1 thanks to AnalystPrep. And now using AnalystPrep for my FRM2 preparation. Professor Forjan is brilliant. He gives such good explanations and analogies. And more than anything makes learning fun. A big thank you to Analystprep and Professor Forjan. 5 stars all the way! michael walshe
2021-03-18
Professor James' videos are excellent for understanding the underlying theories behind financial engineering / financial analysis. The AnalystPrep videos were better than any of the others that I searched through on YouTube for providing a clear explanation of some concepts, such as Portfolio theory, CAPM, and Arbitrage Pricing theory. Watching these cleared up many of the unclarities I had in my head. Highly recommended. Nyka Smith
2021-02-18
Every concept is very well explained by Nilay Arun. kudos to you man! 2021-02-13   