theR-squared)and includinganyvariables thataccomplish
this, the focus of regressions in relative valuations is
narrower. Since our objective is not to explain away all
differencesinpricingacrossfirmsbutonlythosedifferences
thatareexplainedbyfundamentals,wewilluseonlythose
variablesthatarerelatedtothosefundamentals.Theprevious
section where we analyzed multiples using DCF models
shouldyieldvaluableclues.Asanexample,considertheP/E
ratio. Sinceit is determinedby the payoutratio, expected
growth,andrisk,wewillincludeonlythosevariablesinthe
regression.Wewillnotaddothervariablestothisregression,
evenifdoingsoincreasestheexplanatorypower,ifthereis
nofundamentalreasonwhythesevariablesshouldberelated
to P/E ratios.
ILLUSTRATION7.2:RevisitingtheBeverageSector:Sector
Regression
Theprice-earningsratioisafunctionoftheexpectedgrowth
rate, risk and the payout ratio. None of the firms in the
beveragesectorpay significantdividendsbut theydifferin
termsofriskandgrowth.Thefollowingtablesummarizesthe
price-earningsratios,betas,andexpectedgrowthratesforthe
firmsonthelist,andaddsacolumnforthestandarddeviation
in weekly stock returns over the previous two years.