{"id":19117,"date":"2021-08-04T15:18:00","date_gmt":"2021-08-04T15:18:00","guid":{"rendered":"https:\/\/analystprep.com\/study-notes\/?p=19117"},"modified":"2026-06-29T19:10:29","modified_gmt":"2026-06-29T19:10:29","slug":"describe-cyclical-effects-on-valuation-multiples","status":"publish","type":"post","link":"https:\/\/analystprep.com\/study-notes\/cfa-level-2\/describe-cyclical-effects-on-valuation-multiples\/","title":{"rendered":"Valuation Multiples"},"content":{"rendered":"\r\n<script type=\"application\/ld+json\">\r\n{\r\n  \"@context\": \"https:\/\/schema.org\",\r\n  \"@type\": \"QAPage\",\r\n  \"mainEntity\": {\r\n    \"@type\": \"Question\",\r\n    \"name\": \"When is the price-to-book ratio most likely to increase, holding all else constant?\",\r\n    \"answerCount\": 3,\r\n    \"acceptedAnswer\": {\r\n      \"@type\": \"Answer\",\r\n      \"text\": \"The correct answer is B. Expected future earnings growth increases. The price-to-book ratio is positively related to expected earnings growth and negatively related to the required rate of return. Therefore, stronger expected earnings growth increases the price-to-book ratio, while increases in real interest rates or expected inflation generally reduce it by raising required returns.\"\r\n    },\r\n    \"suggestedAnswer\": [\r\n      {\r\n        \"@type\": \"Answer\",\r\n        \"text\": \"Real interest rates increase.\"\r\n      },\r\n      {\r\n        \"@type\": \"Answer\",\r\n        \"text\": \"Expected future earnings growth increase.\"\r\n      },\r\n      {\r\n        \"@type\": \"Answer\",\r\n        \"text\": \"Expected inflation increases.\"\r\n      }\r\n    ]\r\n  }\r\n}\r\n<\/script>\r\n<p><iframe loading=\"lazy\" src=\"\/\/www.youtube.com\/embed\/NFyA0qXHhww\" width=\"611\" height=\"343\" allowfullscreen=\"allowfullscreen\"><\/iframe><\/p>\r\n<p>Valuation multiples include the <strong>price-to-earnings ratio<\/strong> (P\/E) and the <strong>price-to-book ratio<\/strong> (P\/B). A high P\/E ratio implies an expected high growth of a company&#8217;s earnings in the future. Therefore, investors will be more willing to pay a higher price for such a share. A low P\/E ratio relative to the market implies a low growth prospect. Under such circumstances, investors won&#8217;t be willing to pay a higher price for such a share, i.e., one that won&#8217;t yield meaningful returns. The market, status of the economy, sector, or the specific company are the factors that influence the P\/E ratio.<\/p>\r\n\r\n<div style=\"margin: 18px 0;\"><a style=\"display: block; text-align: center; padding: 14px 18px; border: 2px solid #2F5BFF; border-radius: 18px; color: #ffffff ; font-weight: 600; font-size: 16px; text-decoration: none; background-color: #1a73e8 ;\" href=\"https:\/\/analystprep.com\/free-trial\/\" target=\"_blank\" rel=\"noopener noreferrer\">Practice cyclical effects on valuation multiples with our CFA Free Trial.<\/a><\/div>\r\n\r\n<p>The P\/B indicates the extent to which a company&#8217;s net assets cover the value of its shares. Moreover, it shows the strength of an investors&#8217; expectations on a company&#8217;s capacity to generate high returns, on its net assets, adjusted for risk. The higher the P\/B ratio, the greater the expectations for growth, but the lower the safety margin if things do not turn out as expected. As is the case with the P\/E ratio, the market, sector, and stock in question determine what makes up a high\/low P\/B ratio.<\/p>\r\n<p>In conclusion, P\/E and P\/B ratios have a positive relation to real earnings growth. At the same time, they have a negative relation to real interest rates. This is attributable to declining volatility in real GDP growth, expected inflation, uncertainty about future inflation, and equity risk premium.<\/p>\r\n<p>During periods of economic growth, both P\/E and P\/B ratios rise while equity risk premium declines. All these elements are influenced by the business cycle.<\/p>\r\n<blockquote>\r\n<h2>Question<\/h2>\r\n<p>When is the price-to-book ratio <em>most likely<\/em> to increase, holding all else constant?<\/p>\r\n<p>When:<\/p>\r\n<ol type=\"A\">\r\n\t<li>Real interest rates increase.<\/li>\r\n\t<li>Expected future earnings growth increase.<\/li>\r\n\t<li>Expected inflation increases.<\/li>\r\n<\/ol>\r\n<h4><strong>Solution<\/strong><\/h4>\r\n<p><strong>The correct answer is B.<\/strong><\/p>\r\n<p>Price-per-book ratio is positively correlated with expected earnings growth rates and negatively correlated to required returns. Therefore, the price-to-book ratio will rise with increases in expected future earnings growth and with a decrease in the real rate, expected inflation, the risk premium for inflation uncertainty, or the equity risk premium.<\/p>\r\n<\/blockquote>\r\n<p>Reading 43: Economics and Investment Markets<\/p>\r\n<p><em>LOS 43 (j) Describe cyclical effects on valuation multiples.<\/em><\/p>\r\n\r\n<div style=\"text-align: center; margin: 30px 0;\"><a style=\"display: inline-flex; align-items: center; justify-content: center; padding: 12px 26px; border-radius: 9999px; background: #1e5bd8; color: #ffffff; font-weight: bold; text-decoration: none;\" href=\"https:\/\/analystprep.com\/free-trial\/\" target=\"_blank\" rel=\"noopener noreferrer\"> Start Free Trial \u2192 <\/a> <p style=\"margin-top: 12px; font-size: 16px; line-height: 1.5;\">Review cyclical effects on valuation multiples with CFA Level 2 study notes, practice questions, mock exams, and video lessons designed to strengthen your exam preparation.<\/p>\r\n <\/div>","protected":false},"excerpt":{"rendered":"<p>Valuation multiples include the price-to-earnings ratio (P\/E) and the price-to-book ratio (P\/B). A high P\/E ratio implies an expected high growth of a company&#8217;s earnings in the future. Therefore, investors will be more willing to pay a higher price for&#8230;<\/p>\n","protected":false},"author":4,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":""},"categories":[102,473],"tags":[216,564],"class_list":["post-19117","post","type-post","status-publish","format-standard","hentry","category-cfa-level-2","category-portfolio-management","tag-cfa-level-2","tag-portfolio-management","blog-post","no-post-thumbnail","animate"],"acf":[],"yoast_head":"<!-- This site is optimized with the Yoast SEO plugin v27.6 - https:\/\/yoast.com\/product\/yoast-seo-wordpress\/ -->\n<title>Cyclical Effects on Valuation Multiples | CFA L2<\/title>\n<meta name=\"description\" content=\"Learn how valuation multiples like P\/E and P\/B ratios are influenced by real earnings growth, real interest rates, and cyclical market conditions.\" \/>\n<meta name=\"robots\" content=\"index, follow, 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