# pe - PE Ratios Aswath Damodaran Aswath Damodaran 1 Price...

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Aswath Damodaran 1 PE Ratios Aswath Damodaran

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Aswath Damodaran 2 Price Earnings Ratio: Definition PE = Market Price per Share / Earnings per Share n There are a number of variants on the basic PE ratio in use. They are based upon how the price and the earnings are defined. n Price: is usually the current price is sometimes the average price for the year n EPS: earnings per share in most recent financial year earnings per share in trailing 12 months (Trailing PE) forecasted earnings per share next year (Forward PE) forecasted earnings per share in future year
Aswath Damodaran 3 PE Ratio: Descriptive Statistics Distribution of PE Ratios - September 2001 0 200 400 600 800 1000 1200 0-4 4 - 6 6 - 8 8 - 10 10 - 15 15-20 20-25 25-30 30-35 35-40 40 - 45 45- 50 50 -75 75 - 100 > 100 PE ratio Number of firms Current PE Trailing PE Forward PE

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Aswath Damodaran 4 PE: Deciphering the Distribution Current PE Trailing PE Forward PE Mean 30.93 30.33 21.13 Standard Error 2.70 2.74 0.73 Median 15.27 15.20 13.71 Mode 10 0 14 Standard Devia 157.30 150.65 38.22 Kurtosis 795.82 1615.73 224.85 Skewness 26.28 36.04 12.97 Range 5370.00 7090.50 864.91 Maximum 5370.00 7090.50 865.00 Count 3387 3021 2737
Aswath Damodaran 5 PE Ratio: Understanding the Fundamentals n To understand the fundamentals, start with a basic equity discounted cash flow model. n With the dividend discount model, n Dividing both sides by the earnings per share, n If this had been a FCFE Model, P 0 = DPS 1 r - g n P 0 EPS 0 = PE = Payout Ratio*(1 + g n ) r-g n P 0 = FCFE 1 r - g n P 0 EPS 0 = (FCFE/Earnings)*(1 + g n ) r-g n

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Aswath Damodaran 6 PE Ratio and Fundamentals n Proposition: Other things held equal, higher growth firms will have higher PE ratios than lower growth firms. n Proposition: Other things held equal, higher risk firms will have lower PE ratios than lower risk firms n Proposition: Other things held equal, firms with lower reinvestment needs will have higher PE ratios than firms with higher reinvestment rates. n Of course, other things are difficult to hold equal since high growth firms, tend to have risk and high reinvestment rats.
Aswath Damodaran 7 Using the Fundamental Model to Estimate PE For a High Growth Firm n The price-earnings ratio for a high growth firm can also be related to fundamentals. In the special case of the two-stage dividend discount model, this relationship can be made explicit fairly simply: For a firm that does not pay what it can afford to in dividends, substitute FCFE/Earnings for the payout ratio. n Dividing both sides by the earnings per share: P 0 = EPS 0 *Payout Ratio*(1+ g)* 1 - (1+g) n (1+r) n r - g + EPS 0 *Payout Ratio n *(1+g) n *(1+g n ) (r-g n )(1+r) n P 0 EPS 0 = Payout Ratio*(1+g)* 1 - n (1+ r) n r - g Payout Ratio n n n ) (r - g n )(1+ r) n

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Aswath Damodaran 8 Expanding the Model n In this model, the PE ratio for a high growth firm is a function of growth, risk and payout, exactly the same variables that it was a function of for the stable growth firm.
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pe - PE Ratios Aswath Damodaran Aswath Damodaran 1 Price...

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