Transcript Financial Statement Analysis and Security Valuation

Financial Statement Analysis
and Security Valuation
Stephen H. Penman
Prepared by
Peter D. Easton and Gregory A. Sommers
Fisher College of Business
The Ohio State University
With contributions by
Stephen H. Penman – Columbia University
Luis Palencia – University of Navarra, IESE Business School
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2001 All rights
16-1
The Analysis of
Price-Earnings Ratios
Chapter 16
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2001 All rights
16-2
What you will learn in this chapter
•
•
•
•
•
•
•
•
•
Chapter 16
Page 527
What a perfect income statement is
What a normal P/E ratio is
What a non-normal P/E ratio is
Why constant residual earnings imply a normal P/E ratio
Why forecasts of earnings growing at the cost of capital
(cum-dividend) imply a normal P/E ratio
How P/E ratios and P/B ratios fit together
How both transitory earnings and growth affect the P/E
ratio
How unlevered P/E ratios differ from levered P/E ratios
How the analysis of growth and sustainable earnings in
Chapter 12 relates to the P/E ratio
McGraw-Hill/Irwin
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16-3
Forecasting from the
Perfect Income Statement
Chapter 16
Pages 528-530
• The perfect balance sheet:
earn1    E  1 CSE0
earn 2   E   E  CSE0
2
earn 3   E   E  CSE0
3
2
earn t   E   E
t 1
t
 CSE
0
Current CSE yields the forecast of all future earnings:
book values will earn at the cost of capital
• The perfect income statement (no dividends)
earn1   E earn0
earn 2   E earn0
2
earn 3   E earn0
3
earn t   E earn0
t
Current earnings yields the forecast of all future earnings:
earnings will increase at the cost of capital
McGraw-Hill/Irwin
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16-4
V0  CSE0 
E
R E1
E

R E2

2
E

Chapter 16
Pages 528-530
RE 0  earn0   E  1CSE1
Forecasting
RE from a
Perfect
Income
Statement
(No
Dividends)
RE 1  earn1    E  1CSE0
  E earn0    E  1CSE0
  E earn0    E  1CSE1  earn0 
No Dividends 
 earn0    E  1CSE1
 RE 0
Similarly, RE 2  RE0 ; RE 3  RE0 ; RE 4  RE0 
This is an SF2 forecast
• Earnings growing at the cost of capital implies RE
will be constant at their current level
• A perfect income statement forecasts constant RE
McGraw-Hill/Irwin
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16-5
Valuation From the Perfect Income
Statement (No Dividends)
Chapter 16
Page 531
Table 16-1
• If the RE is expected to be constant at current levels,
RE0 can be capitalized. The SF2 valuation is:
E
0
V
 CSE0 
earn0    E  1CSE1
E 1
• This can be expressed in an easier form:
V0  CSE0 
E
 CSE0 
 CSE0 

McGraw-Hill/Irwin
E
E 1
earn0    E  1 CSE1
E 1
earn0    E  1 CSE0  earn0 
(No Dividends)
E 1
earn0    E  1 earn0
E 1
 CSE0
earn0
© The McGraw-Hill Companies, Inc., 2001 All rights
16-6
Forecasting From the Perfect
Income Statement With Dividends
Chapter 16
Page 530
The SF2 forecast of constant RE is the same as
earn1  earn0   E  1 DCSE0
but DCSE0 = earn0 - d0;
So
earn1  earn0   E  1 earn0  d 0 
  E earn0   E  1 d 0
This is just the dividends displacement idea: earnings will
grow at the cost of capital, cum-dividend, but dividends
displace earnings
McGraw-Hill/Irwin
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16-7
Valuation From the Perfect Income
Statement With Dividends
Chapter 16
Page 528
If RE is expected to be constant at current levels,
E
0
V
 CSE0 
earn0   E  1 CSE1
 E 1
Add current dividend, d0, to both sides and divide by earn0:
V0  d 0
E

earn0
CSE0  d 0
earn0
 1
CSE1
earn0
 1

McGraw-Hill/Irwin


1
E 1
1
E 1


CSE1
earn0
CSE1
earn0
1
E 1
E
E 1
© The McGraw-Hill Companies, Inc., 2001 All rights
16-8
The Normal P/E Ratio
V0  d 0
E
earn0

Chapter 16
Page 528
E
E 1
Dividends affect price but not current earnings so
they are added to price to set it cum-dividends. P/E
ratios are then not affected by payout
If the cost of equity capital is 10%, the normal P/E is 11
If the cost of equity capital is 12%, it is 9.33
McGraw-Hill/Irwin
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16-9
Cost of Capital and
Normal P/E Ratios
Cost of
Capital
8.0%
9.0%
10.0%
11.0%
12.0%
13.0%
14.0%
15.0%
16.0%
17.0%
18.0%
19.0%
20.0%
McGraw-Hill/Irwin
Expected
Normal P/E
13.50
12.11
11.00
10.09
9.33
8.69
8.14
7.67
7.25
6.88
6.56
6.26
6.00
Normal
P/E
6
7
8
9
10
11
12
13
14
15
16
17
18
Implied Cost
of Capital
20.00%
16.67%
14.29%
12.50%
11.11%
10.00%
9.09%
8.33%
7.69%
7.14%
6.67%
6.25%
5.88%
© The McGraw-Hill Companies, Inc., 2001 All rights
16-10
Chapter 16
Page 531
Table 16-1
The Normal P/B and
the Normal P/E
Normal P/B Ratio
Normal P/E Ratio
Book values expected
to grow at equity cost
of capital
Earnings expected to
grow at equity cost of
capital
Residual Earnings
expected to be zero
Residual Earnings expected to
be same as current residual
earnings
An SF1 Forecast
An SF2 Forecast
Vo  CSEO
E
V  do 
E
o
E
o
V
McGraw-Hill/Irwin
E
 E 1
 CSEo 
 earno
RE o
E 1
© The McGraw-Hill Companies, Inc., 2001 All rights
16-11
A Normal P/E:
Whirlpool Corporation
Chapter 16
Page 531
Box 16.1
______________________________________________________________________________
Whirlpool Corp.: Analyst Forecast, December, 1994
1993A
1994A
1995E
1996E
1997E
Eps
4.43
4.75
5.08
5.44
Dps
1.22
1.28
1.34
1.41
25.83
29.30
33.04
37.07
2.15
2.17
2.15
2.14
Bps
22.85
RE (.10)
______________________________________________________________________________
Valuation:
E
1994
V
 B1994 
V1994  d1994
RE1994
 E  1
E
earn1994

 25.83 
47.33  1.22
2.15
 47.33
0.10
 11.00
4.43
This is a normal P/E for a 10% cost of capital
McGraw-Hill/Irwin
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16-12
Forecasted RE and NI for a
Normal P/E: Whirlpool Corporation
Chapter 16
Page 532
Box 16.1
For Whirlpool, RE is forecasted to be
constant. But cum-dividend earnings is also
expected to grow at the cost of capital:
________________________________________________________________________
Whirlpool Corp.
Analyst’s eps forecast
Dps forecast
Cum-dividend earnings:
Earnings forecast
Dividend displacement
- 1994 dividends
- 1995 dividends
- 1996 dividends
Cum-dividend earnings
Year-to-year earnings growth
1994A
4.43
1995E
4.75
1996E
5.08
1997E
5.44
1.22
1.28
1.34
1.41
4.43
4.75
5.08
5.44
.12
____
4.43
____
4.87
.13
.13
____
5.34
.15
.14
.13
5.86
10%
10%
10%
________________________________________________________________________
McGraw-Hill/Irwin
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16-13
P/E Ratios Different from Normal
Chapter 16
Page 530
• If earnings are expected to grow faster than the cost of
capital (cum-dividend), P/E > Normal
• If earnings are expected to grow slower than the cost of
capital (cum-dividend), P/E < Normal
OR
• If RE is forecasted to increase, P/E > Normal
• If RE is forecasted to decrease, P/E < Normal
McGraw-Hill/Irwin
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16-14
Earnings Growth Rates (Cum-Dividend)
for Different P/E Ratios
Chapter 16
Page 533
Table 16.2
______________________________________________________________________________
P/E
Group
P/E
0
1
Year After P/E Groups are Formed (Year 0)
2
3
4
5
6
1
*
-2.193
0.815
0.590
0.439
0.303
0.284
0.200
2
*
-0.966
1.127
0.478
0.205
0.219
0.143
0.174
3
58.8
-0.223
0.745
0.301
0.198
0.172
0.141
0.119
4
25.6
0.039
0.522
0.175
0.178
0.150
0.146
0.134
5
19.2
0.109
0.239
0.180
0.162
0.155
0.164
0.153
6
15.9
0.149
0.197
0.152
0.149
0.170
0.152
0.149
7
13.9
0.133
0.184
0.139
0.153
0.146
0.142
0.151
8
12.5
0.153
0.162
0.138
0.139
0.144
0.150
0.162
9
11.5
0.140
0.143
0.135
0.137
0.143
0.141
0.136
10
10.6
0.145
0.144
0.133
0.126
0.131
0.126
0.116
11
9.8
0.140
0.118
0.116
0.137
0.158
0.142
0.112
12
9.2
0.135
0.116
0.132
0.136
0.133
0.134
0.134
13
8.6
0.143
0.111
0.131
0.130
0.139
0.124
0.135
14
8.1
0.141
0.107
0.104
0.136
0.120
0.120
0.129
15
7.5
0.154
0.099
0.115
0.121
0.139
0.120
0.126
16
7.0
0.166
0.077
0.110
0.139
0.148
0.130
0.122
17
6.5
0.165
0.072
0.107
0.141
0.136
0.136
0.115
18
5.9
0.184
0.048
0.102
0.123
0.131
0.127
0.130
19
5.2
0.209
0.005
0.070
0.133
0.144
0.156
0.124
20
3.9
0.287
-0.053
0.082
0.129
0.135
0.180
0.140
____________________________________________________________________________________________
All NYSE and AMEX firms; 1968-85
McGraw-Hill/Irwin
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16-15
Residual Earnings for Different P/E Ratios:
All NYSE and AMEX firms; 1968-85
Chapter 16
Page 533
Table 16.2
______________________________________________________________________________
P/E
Group
P/E
0
1
Year After P/E Groups are Formed (Year 0)
2
3
4
5
6
1
*
-0.299
-0.117
-0.053
-0.030
-0.015
-0.006
-0.005
2
*
-0.131
-0.070
-0.036
-0.023
-0.002
-0.005
0.004
3
58.8
-0.039
0.000
0.019
0.028
0.037
0.040
0.039
4
25.6
0.009
0.034
0.038
0.054
0.061
0.062
0.080
5
19.2
0.024
0.049
0.060
0.060
0.066
0.069
0.076
6
15.9
0.036
0.048
0.053
0.053
0.056
0.067
0.077
7
13.9
0.038
0.052
0.058
0.055
0.063
0.068
0.073
8
12.5
0.041
0.049
0.047
0.050
0.053
0.060
0.067
9
11.5
0.034
0.044
0.041
0.046
0.055
0.064
0.075
10
10.6
0.040
0.043
0.043
0.044
0.051
0.052
0.051
11
9.8
0.038
0.041
0.038
0.043
0.051
0.058
0.053
12
9.2
0.036
0.039
0.040
0.041
0.047
0.050
0.052
13
8.6
0.035
0.038
0.038
0.041
0.047
0.052
0.058
14
8.1
0.037
0.037
0.037
0.042
0.045
0.050
0.053
15
7.5
0.037
0.036
0.040
0.039
0.048
0.049
0.052
16
7.0
0.040
0.035
0.037
0.041
0.046
0.050
0.057
17
6.5
0.045
0.040
0.037
0.040
0.045
0.053
0.054
18
5.9
0.052
0.044
0.038
0.040
0.040
0.045
0.057
19
5.2
0.058
0.041
0.035
0.036
0.041
0.048
0.048
20
3.9
0.080
0.048
0.041
0.040
0.037
0.048
0.054
____________________________________________________________________________________________
McGraw-Hill/Irwin
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16-16
Chapter 16
Page 534
The P/E Ratio and the P/B Ratio
• P/B indicates expected growth in book value
• P/E indicates expected growth in earnings
OR
• P/B indicates future RE
• P/E indicates future changes in RE from current RE
McGraw-Hill/Irwin
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16-17
______________________________________________________________________________
Year
Median
Median
T-Note
P/B
P/E
Rate (%)
______________________________________________________________________________
P/B and
P/E
Ratios:
1968-93
1968
2.49
21.3
5.7
69
1.64
15.6
7.0
70
1.35
15.9
7.3
71
1.46
17.2
5.7
72
1.36
13.9
5.7
73
.87
7.9
7.0
74
.56
5.8
7.8
75
.75
7.9
7.5
76
.89
8.1
6.8
77
.91
7.8
6.7
78
.93
7.5
8.3
79
.99
7.8
9.7
80
1.17
10.4
11.6
81
1.15
10.9
14.4
82
1.24
16.1
12.9
83
1.68
18.9
10.5
84
1.45
16.1
11.9
85
1.69
22.7
9.6
86
1.81
26.3
7.1
87
1.60
22.7
7.7
88
1.63
19.6
8.3
89
1.73
23.3
8.6
90
1.41
22.7
8.3
91
1.77
32.3
6.8
92
1.92
29.4
5.3
93
1.97
25.6
4.4
______________________________________________________________________________
Average
1.40
13.2
8.2
1968-93
______________________________________________________________________________
For 1968-74 the medians are for all NYSE and AMEX firms; for 1975-93 the medians are for all NYSE, AMEX and
McGraw-Hill/Irwin NASDAQ firms.
© The McGraw-Hill Companies, Inc., 2001 All rights
16-18
Median E/P for P/B
Portfolios: 1968-85
_______________________________________________________
P/B
Median
Median
Portfolio
P/B
E/P
_______________________________________________________
1
6.20
.040
2
3.66
.055
3
2.82
.067
4
2.33
.077
5
2.00
.085
6
1.76
.091
7
1.58
.097
8
1.43
.102
9
1.31
.105
10
1.22
.110
11
1.13
.115
12
1.05
.121
13
.98
.126
14
.92
.130
15
.85
.130
16
.79
.129
17
.72
.129
18
.64
.127
19
.54
.113
20
.39
.084
______________________________________________________
McGraw-Hill/Irwin
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16-19
Median P/B for E/P
Portfolios: 1968-85
_______________________________________________________
E/P
Median
Median
Portfolio
E/P
P/B
_______________________________________________________
McGraw-Hill/Irwin
1
.255
.645
2
.193
.806
3
.169
.889
4
.154
.938
5
.142
.988
6
.133
1.038
7
.124
1.107
8
.116
1.162
9
.109
1.251
10
.102
1.350
11
.094
1.460
12
.087
1.545
13
.080
1.744
14
.072
1.902
15
.063
2.081
16
.052
2.254
17
.039
2.473
18
.017
2.304
19
-.046
1.428
20
-.417
.833
______________________________________________________
© The McGraw-Hill Companies, Inc., 2001 All rights
16-20
How do P/E and P/B Articulate?
Chapter 16
Page 534
Table 16-3
P/B
High
Low
High
15,211
(32.8%)
7,757
(16.7%)
Low
7,907
(17.1%)
15,460
(33.4%)
P/E
Joint Values of P/E and P/B Ratios; 1968-85
McGraw-Hill/Irwin
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16-21
Chapter 16
Page 534
Table 16-4
Fill Out the Cells
High
P/E Normal
Low
High
P/B
Normal
Low
A
B
C
D
E
F
G
H
I
Which cell do growth firms fall in ?
McGraw-Hill/Irwin
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16-22
Chapter 16
Page 535
Table 16-5
The Solution
P/B
High
P/E Normal
Low
High
(RE>0
)
A RE>RE
0
D RE=RE
0
RE0>0
G RE<RE
0
RE0>0
Normal
(RE=0)
Low
(RE<0)
B
RE0<0
C
E
RE=RE0
RE0=0
F
RE>RE0
RE0<0
RE=RE0
RE0<0
H
RE0>0
I
RE<RE0
RE = Expected future residual earnings
RE0 = Current residual earnings
McGraw-Hill/Irwin
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16-23
What is a Growth Stock ?
Chapter 16
Page 537
• P/E indicates growth in RE but this could be from a very
low base: Firms in cell C can be high P/E firms
• P/B is a better indicator for growth: the ability to generate
high RE in the future (i.e., add to book value)
• P/E reflects growth and transitory earnings. If earnings are
temporarily low, P/E will be high
The Molodovsky Effect:
– Cells B and H are pure Molodovsky effects
– Cells A, C, G and I are mixed growth and Molodovsky
effects
McGraw-Hill/Irwin
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16-24
Residual Income for P/E Groups for
Different Levels of P/B: 1968-85
P/E Group
0
Year Ahead of Portfolio Formation (Year 0)
1
2
3
6
Panel A: P/B > 1.10
1
-0.501
-0.073
-0.005
0.012
0.008
2
-0.145
-0.028
0.004
0.013
0.030
3
-0.012
0.038
0.054
0.063
0.059
4
0.048
0.068
0.078
0.078
0.108
5
0.055
0.082
0.091
0.095
0.111
6
0.065
0.080
0.084
0.083
0.112
7
0.069
0.083
0.089
0.087
0.111
8
0.071
0.080
0.081
0.082
0.107
9
0.072
0.080
0.079
0.087
0.109
10
0.075
0.080
0.078
0.080
0.080
11
0.077
0.079
0.076
0.083
0.110
12
0.085
0.084
0.085
0.085
0.108
13
0.092
0.094
0.090
0.088
0.128
14
0.095
0.099
0.086
0.085
0.140
15
0.118
0.118
0.098
0.096
0.112
16
0.131
0.131
0.126
0.113
0.225
17
0.157
0.142
0.124
0.097
0.085
18
0.182
0.157
0.088
0.086
0.083
19
0.244
0.177
0.134
0.091
0.095
20 Low
0.408
0.247
0.177
0.165
0.236
______________________________________________________________________________
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2001 All rights
16-25
Residual Income for P/E Groups for
Different Levels of P/B: 1968-85
P/E Group
0
Year Ahead of Portfolio Formation (Year 0)
1
2
3
6
Panel B: 1.10  P/B  .90
1
-0.361
-0.129
-0.050
-0.018
0.002
2
-0.150
-0.082
-0.054
-0.039
-0.058
3
-0.086
-0.062
-0.048
-0.023
-0.018
4
-0.060
-0.042
0.001
0.017
0.005
5
-0.047
-0.027
-0.026
-0.044
0.070
6
-0.036
-0.045
-0.001
-0.001
0.000
7
-0.023
-0.019
-0.027
-0.034
0.010
8
-0.014
-0.012
-0.009
0.003
0.020
9
-0.006
0.001
0.004
0.013
0.042
10
0.002
0.009
0.018
0.023
0.052
11
0.011
0.011
0.019
0.022
0.089
12
0.019
0.014
0.028
0.033
0.067
13
0.028
0.025
0.035
0.037
0.058
14
0.037
0.036
0.033
0.042
0.064
15
0.046
0.048
0.053
0.048
0.066
16
0.060
0.062
0.065
0.070
0.126
17
0.077
0.059
0.049
0.054
0.057
18
0.095
0.067
0.036
0.039
0.072
19
0.141
0.096
-0.059
0.041
0.121
20
0.219
0.149
0.087
0.006
0.041
______________________________________________________________________________
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2001 All rights
16-26
Residual Income for P/E Groups for
Different Levels of P/B: 1968-85
P/E Group
0
Year Ahead of Portfolio Formation (Year 0)
1
2
3
6
Panel C: P/B < .90
1
-0.247
-0.132
-0.064
-0.043
-0.011
2
-0.127
-0.093
-0.053
-0.037
-0.022
3
-0.093
-0.076
-0.041
-0.043
-0.023
4
-0.077
-0.063
-0.046
-0.007
-0.011
5
-0.068
-0.062
-0.045
-0.080
-0.003
6
-0.057
-0.055
-0.038
-0.025
0.018
7
-0.049
-0.044
-0.030
-0.015
-0.021
8
-0.041
-0.040
-0.032
-0.013
0.014
9
-0.036
-0.036
-0.030
-0.010
0.021
10
-0.031
-0.022
-0.014
0.002
0.007
11
-0.023
-0.026
-0.011
0.001
0.031
12
-0.018
-0.021
-0.008
-0.001
0.018
13
-0.013
-0.016
-0.006
0.010
0.030
14
-0.007
-0.007
0.001
0.011
0.024
15
0.001
-0.005
0.008
0.012
0.031
16
0.002
0.000
0.001
0.009
0.028
17
0.013
0.003
0.010
0.015
0.040
18
0.022
0.010
0.017
0.022
0.039
19
0.033
0.017
0.019
0.023
0.030
20
0.062
0.036
0.031
0.033
0.048
______________________________________________________________________________
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2001 All rights
16-27
What Does Current ROCE Say
About the P/E and P/B Ratios?
E/P ratios and P/B ratios for ROCE groups: 1968-85
____________________________________________________
ROCE
Median
Median
Portfolio
E/P
P/B
_______________________________________________________
McGraw-Hill/Irwin
1
.104
3.425
2
.101
2.570
3
.102
2.199
4
.104
1.890
5
.109
1.650
6
.116
1.454
7
.116
1.361
8
.120
1.252
9
.121
1.161
10
.120
1.101
11
.119
1.056
12
.119
.995
13
.111
.970
14
.109
.906
15
.103
.841
16
.091
.797
17
.070
.781
18
.036
.753
19
-.043
.741
20
-.347
1.008
______________________________________________________
© The McGraw-Hill Companies, Inc., 2001 All rights
16-28
Chapter 16
Page 531
Box 16.1
A Normal P/E:
Whirlpool Corporation
______________________________________________________________________________
Whirlpool Corp.: Analyst Forecast, December, 1994
1993A
2.10
Eps
Dps
Bps
22.85
RE (.10)
1994A
1995E
1996E
1997E
4.43
4.75
5.08
5.44
1.22
1.28
1.34
1.41
25.83
29.30
33.04
37.07
2.15
2.17
2.15
2.14
______________________________________________________________________________
Valuation:
E
1994
V
 25.83 
V1994  d1994
2.15
0.10
E
earn1994
 47.33

47.33  1.22
 11.00
4.43
This is a normal P/E for a 10% cost of capital
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2001 All rights
16-29
The P/E Ratio:
The Two Component Calculation
Chapter 16
Page 538
V0  CSE0  PV of Future RE
E
V0  d 0
E

CSE0  d 0
earn0

earn0
PV of Future RE
earn0
but as CSE0 + d0 = CSE-1 + earn0, this
is E
V0  d 0
CSE1 PV of Future RE
 1

earn0
earn0
earn0
 1
1
ROCE 0
McGraw-Hill/Irwin

PV of Future RE
earn0
© The McGraw-Hill Companies, Inc., 2001 All rights
16-30
A Constant Growth Model of the P/E
Chapter 16
Page 539
This is equal to
V0  d 0
E
earn0

 E ( g  1) 
 1
g 

 E  g  
ROCE 0 
1
Special case: set g=1
P/E 
McGraw-Hill/Irwin
E
E 1
© The McGraw-Hill Companies, Inc., 2001 All rights
16-31
Chapter 16
Page 540
Box 16.3
The Effect of Stock Repurchases
Before Stock Repurchase
Net operating assets
Common equity
Operating income (Comp Inc)
Eps (on 10 million shares)
Growth in eps
RNOA
ROCE
Residual operating income
Value of equity
Per-share value of equity
(10 million shares)
P/E ratio
–1
90.90
90.90
0
100.00
100.00
9.09
0.91
10%
10%
0
10%
10%
0
100.00
1
110.00
110.00
10.00
1.00
10.0%
10%
10%
0
110.00
2
121.00
121.00
11.00
1.10
10.0%
10%
10%
0
121.00
3
133.10
133.10
12.10
1.21
10.0%
10%
10%
10.00
11.0
11.00
11.0
12.10
11.0
13.10
11.0
133.10
Beware: Earnings growth can be created by
leverage and stock transactions
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2001 All rights
16-32
Chapter 16
Page 541
Box 16.3
The Effect of Stock Repurchases
After Stock Repurchase
Net operating assets
Net financial obligations
Common equity
Operating income
Net financial expense
Comprehensive income
Eps (on 5 million shares)
Growth in eps
RNOA
ROCE
Residual operating income
Value of equity
Per-share value of equity
(5 million shares)
P/E ratio
–1
90.90
90.90
0
100.00
50.00
50.00
9.09
1
2
3
10%
10%
0
50.00
110.00
52.50
57.50
10.00
2.50
7.50
1.50
65.0%
10%
15.0%
0
57.50
121.00
55.12
65.88
11.00
2.63
8.37
1.68
11.6%
10%
14.6%
0
65.88
133.10
57.88
75.22
12.10
2.76
9.34
1.87
11.6%
10%
14.2%
0
75.22
10.00
11.0
11.50
7.67
13.18
7.86
15.04
8.04
9.09
0.91
Beware: Earnings growth can be created by
leverage and stock transactions
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2001 All rights
16-33
Chapter 16
Page 542
Levered and Unlevered P/E Ratios
Data from Exercise 16.4 (page 548):
2000
1,300
300
1,000
Net operating assets
Net financial obligations
Common shareholders’ equity
2001
1,300
300
1,000
2002
1,300
300
1,000
2003
1,300
300
1,000
135
15
120
135
15
120
135
15
120
Operating income
Net financial expense
Earnings
levered P/E 
1200  120
unlevered P/E 
 11
120
1200  300  135
 12.11
135
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2001 All rights
16-34
Chapter 16
Page 543
Figure 16.1
Median Levered & Unlevered P/E Ratios,
1963-96 (NYSE and AMEX firms)
30
25
20
15
Unlevered P/E
10
Levered P/E
5
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2001 All rights
1996
1995
1994
1993
1992
1991
1990
1989
1988
1987
1986
1985
1984
1983
1982
1981
1980
1979
1978
1977
1976
1975
1974
1973
1972
1971
1970
1969
1968
1967
1966
1965
1964
1963
0
16-35