ThekeydeterminantsoftheP/Eratioaretheexpectedgrowth
rateinearningspershare,thecostofequity,andthepayout
ratio.Otherthingsremainingequal,wewouldexpecthigher
growth,lowerriskand higherpayoutratiofirmstotradeat
higher multiples of earnings than firms without these
characteristics.
Dividing both sides by the book value of equity, we can
estimatetheprice/bookvalue(P/BV)ratioforastablegrowth
firm.
whereROEisthereturnonequityandistheonlyvariablein
additiontothethreethatdetermineP/Eratios(growthrate,
cost of equity, and payout) that affects price-to-book equity.
Dividingbythesalespershare,theprice/sales(PS)ratiofora
stable-growthfirmcanbeestimatedasafunctionofitsprofit
margin, payout ratio, risk, and expected growth.
The net margin is the new variable that is added to the
process. While all of these computations are based on a
stable-growthdividenddiscountmodel,wewillshowthatthe
conclusionsholdevenwhenwelookatcompanieswithhigh
growth potential and with other equity valuation models.