To alleviate thesecond problem, the regression wasrerun
without an intercept, with the following results:
Not only is this regression less likely to yield negative
predictedvalues,butthecoefficientonbetanowhastheright
sign: Higher-beta companies have lower price-to-sales ratios.
Comparing Equity Multiples across Time
AnalystsandmarketstrategistsoftencomparetheP/Eratioof
amarket toits historicalaverageto makejudgmentsabout
whether themarket is undervalued or overvalued. Thus, a
marketthatistradingataP/Eratiothatismuchhigherthan
its historical norm is often considered to be overvalued,
whereas one that istrading at a ratio lower is considered
undervalued.
Whilereversiontohistoricnormsremainsaverystrongforce
infinancialmarkets,weshouldbecautiousaboutdrawingtoo
strong a conclusion from such comparisons. As the
fundamentals(interestrates,riskpremiums,expectedgrowth,
andpayout)changeovertime,theP/Eratiowillalsochange.
Otherthingsremainingequal,forinstance,wewouldexpect
the following.
- Anincreaseininterestratesshouldresultinahigher
cost of equity for the market and a lower P/E ratio. - A greater willingness to take risk on the part of
investors will result in a lower risk premium for
equity and a higher P/E ratio across all stocks.