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Unformatted text preview: Aswath Damodaran 1 Relative PE Aswath Damodaran Aswath Damodaran 2 Relative PE: Definition n The relative PE ratio of a firm is the ratio of the PE of the firm to the PE of the market. Relative PE = PE of Firm / PE of Market n While the PE can be defined in terms of current earnings, trailing earnings or forward earnings, consistency requires that it be estimated using the same measure of earnings for both the firm and the market. n Relative PE ratios are usually compared over time. Thus, a firm or sector which has historically traded at half the market PE (Relative PE = 0.5) is considered over valued if it is trading at a relative PE of 0.7. Aswath Damodaran 3 Relative PE: Cross Sectional Distribution Relative PE 1000 800 600 400 200 Std. Dev = .77 Mean = 1.00 N = 3303.00 Aswath Damodaran 4 Relative PE: Distributional Statistics n The average relative PE is always one. n The median relative PE is much lower, since PE ratios are skewed towards higher values. Thus, more companies trade at PE ratios less than the market PE and have relative PE ratios less than one. Aswath Damodaran 5 Relative PE: Determinants n To analyze the determinants of the relative PE ratios, let us revisit the discounted cash flow model we developed for the PE ratio. Using the 2stage DDM model as our basis (replacing the payout ratio with the FCFE/Earnings Ratio, if necessary), we get where Payout j , g j , r j = Payout, growth and risk of the firm Payout m , g m , r m = Payout, growth and risk of the market Relative PE j = Payout Ratio j * ( 1+ g j ) * 1 ( 1 +g j ) n ( 1 +r j...
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This note was uploaded on 01/29/2012 for the course FIN 6000 taught by Professor Banko during the Fall '11 term at University of Florida.
 Fall '11
 BANKO

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