IDEAS home Printed from https://ideas.repec.org/a/spr/reaccs/v21y2016i2d10.1007_s11142-016-9356-0.html
   My bibliography  Save this article

Structural properties of the price-to-earnings and price-to-book ratios

Author

Listed:
  • Alexander Nezlobin

    () (University of California)

  • Madhav V. Rajan

    () (Stanford University)

  • Stefan Reichelstein

    () (Stanford University)

Abstract

Abstract We examine the structural properties of a firm’s price-to-earnings (P/E) and price-to-book (P/B) ratios and the relation between these two ratios. A benchmark result is obtained under the hypothesis that firms use replacement cost accounting to value their operating assets, so that the P/B ratio coincides with Tobin’s q. The firm’s P/E ratio can then be expressed as a convex combination of the P/E ratios suggested respectively by the permanent earnings model and the Gordon growth model, with the relative weight to be placed on these two endpoints determined entirely by Tobin’s q. Under current financial reporting rules, the accounting for operating assets is likely to be more conservative than replacement cost accounting. Our findings characterize how the magnitude and behavior of the P/E and P/B ratios are jointly shaped by several key variables, including both past and anticipated future growth, economic profitability, and accounting conservatism

Suggested Citation

  • Alexander Nezlobin & Madhav V. Rajan & Stefan Reichelstein, 2016. "Structural properties of the price-to-earnings and price-to-book ratios," Review of Accounting Studies, Springer, vol. 21(2), pages 438-472, June.
  • Handle: RePEc:spr:reaccs:v:21:y:2016:i:2:d:10.1007_s11142-016-9356-0
    DOI: 10.1007/s11142-016-9356-0
    as

    Download full text from publisher

    File URL: http://link.springer.com/10.1007/s11142-016-9356-0
    File Function: Abstract
    Download Restriction: Access to the full text of the articles in this series is restricted.

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    as
    1. Lakonishok, Josef & Shleifer, Andrei & Vishny, Robert W, 1994. " Contrarian Investment, Extrapolation, and Risk," Journal of Finance, American Finance Association, vol. 49(5), pages 1541-1578, December.
    2. Timothy Erickson & Toni M. Whited, 2006. "On the Accuracy of Different Measures of q," Financial Management, Financial Management Association International, vol. 35(3), pages 5-33, September.
    3. Rogerson William P, 2011. "On the Relationship Between Historic Cost, Forward Looking Cost and Long Run Marginal Cost," Review of Network Economics, De Gruyter, vol. 10(2), pages 1-31, June.
    4. Tobin, James, 1969. "A General Equilibrium Approach to Monetary Theory," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 1(1), pages 15-29, February.
    5. Alexander Nezlobin & Madhav V. Rajan & Stefan Reichelstein, 2012. "Dynamics of Rate-of-Return Regulation," Management Science, INFORMS, vol. 58(5), pages 980-995, May.
    6. Stavros B. Thomadakis, 1976. "A Model of Market Power, Valuation and the Firm's Returns," Bell Journal of Economics, The RAND Corporation, vol. 7(1), pages 150-162, Spring.
    7. William P. Rogerson, 2008. "Intertemporal Cost Allocation and Investment Decisions," Journal of Political Economy, University of Chicago Press, vol. 116(5), pages 931-950, October.
    8. Bekaert, Geert & Engstrom, Eric, 2010. "Inflation and the stock market: Understanding the "Fed Model"," Journal of Monetary Economics, Elsevier, vol. 57(3), pages 278-294, April.
    9. Perfect, Steven B. & Wiles, Kenneth W., 1994. "Alternative constructions of Tobin's q: An empirical comparison," Journal of Empirical Finance, Elsevier, vol. 1(3-4), pages 313-341, July.
    10. Hayashi, Fumio, 1982. "Tobin's Marginal q and Average q: A Neoclassical Interpretation," Econometrica, Econometric Society, vol. 50(1), pages 213-224, January.
    11. Lindenberg, Eric B & Ross, Stephen A, 1981. "Tobin's q Ratio and Industrial Organization," The Journal of Business, University of Chicago Press, vol. 54(1), pages 1-32, January.
    12. Avinash K. Dixit & Robert S. Pindyck, 1994. "Investment under Uncertainty," Economics Books, Princeton University Press, edition 1, number 5474.
    13. Alexander Nezlobin, 2012. "Accrual Accounting, Informational Sufficiency, and Equity Valuation," Journal of Accounting Research, Wiley Blackwell, vol. 50(1), pages 233-273, March.
    14. Gary Biglaiser & Michael Riordan, 2000. "Dynamics of Price Regulation," RAND Journal of Economics, The RAND Corporation, vol. 31(4), pages 744-767, Winter.
    15. Madhav V. Rajan & Stefan Reichelstein, 2009. "Depreciation Rules and the Relation between Marginal and Historical Cost," Journal of Accounting Research, Wiley Blackwell, vol. 47(3), pages 823-865, June.
    16. repec:bla:joares:v:34:y:1996:i:2:p:209-234 is not listed on IDEAS
    17. repec:bla:joares:v:34:y:1996:i:2:p:235-259 is not listed on IDEAS
    18. Maureen McNichols & Madhav V. Rajan & Stefan Reichelstein, 2014. "Conservatism Correction for the Market-To-Book Ratio and Tobin's q," CESifo Working Paper Series 4626, CESifo Group Munich.
    19. Fisher, Franklin M & McGowan, John J, 1983. "On the Misuse of Accounting Rates of Return to Infer Monopoly Profits," American Economic Review, American Economic Association, vol. 73(1), pages 82-97, March.
    20. Louis K. C. Chan & Jason Karceski & Josef Lakonishok, 2003. "The Level and Persistence of Growth Rates," Journal of Finance, American Finance Association, vol. 58(2), pages 643-684, April.
    21. Basu, S, 1977. "Investment Performance of Common Stocks in Relation to Their Price-Earnings Ratios: A Test of the Efficient Market Hypothesis," Journal of Finance, American Finance Association, vol. 32(3), pages 663-682, June.
    22. Salamon, Gerald L, 1985. "Accounting Rates of Return," American Economic Review, American Economic Association, vol. 75(3), pages 495-504, June.
    23. Zhang, Xiao-Jun, 2000. "Conservative accounting and equity valuation," Journal of Accounting and Economics, Elsevier, vol. 29(1), pages 125-149, February.
    24. repec:hrv:faseco:30721347 is not listed on IDEAS
    25. Joao F. Gomes, 2001. "Financing Investment," American Economic Review, American Economic Association, vol. 91(5), pages 1263-1285, December.
    26. Jaffe, Jeffrey & Keim, Donald B & Westerfield, Randolph, 1989. " Earnings Yields, Market Values, and Stock Returns," Journal of Finance, American Finance Association, vol. 44(1), pages 135-148, March.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. repec:spr:reaccs:v:22:y:2017:i:3:d:10.1007_s11142-017-9402-6 is not listed on IDEAS
    2. repec:gam:jsusta:v:11:y:2019:i:7:p:1938-:d:219072 is not listed on IDEAS

    More about this item

    Keywords

    Price-to-earnings; Price-to-book; Tobin’s q; Growth; Profitability; Conservatism;

    JEL classification:

    • M41 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Accounting
    • L25 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Firm Performance
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:spr:reaccs:v:21:y:2016:i:2:d:10.1007_s11142-016-9356-0. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Sonal Shukla) or (Springer Nature Abstracting and Indexing). General contact details of provider: http://www.springer.com .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.