P/E-ratios in Relative Valuation - a Mission Impossible?
AbstractRelative P/E-ratio valuation apparently still plays an important role among investment research analysts and advisors (cf. Goldman Sachs,1999). In a valuation model of this kind, the value of owners´equity is typically calculated as a function of an observed P/E-ratio for some peer company, or the mean/median P/E-ratio for some group of peer companies. The research question being addressed in the paper is concerned with the validity of a benchmark P/E-ratio being assessed in this way. Assuming that there is only one peer company, the importance of differences (between the company being valued and its peer company) with regard to the book return on owners´equity and the growth of owners´equity have been investigated. In the main, it is shown that relative P/E-ratio valuation will not be able to handle differences in the expected book return or growth of owners´equity. In an empirical context, however, controlling for industry and the expected book return for next year, together with some modification of the valuation model itself, can improve the quality of earnings-based relative valuation.
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Bibliographic InfoPaper provided by Stockholm School of Economics in its series Working Paper Series in Business Administration with number 2001:7.
Length: 29 pages
Date of creation: 30 Apr 2001
Date of revision:
Publication status: Published in Investment Management and Financial Innovations, 2008, pages 237-248.
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equity valuation; financial statement analysis; P/E-ratio; relative valuation; valuation modelling;
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