Blog: Understanding PE

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6 comment(s). Last comment by 3iii 2016-03-10 19:36

Willie Ong

4 posts

Posted by Willie Ong > 2016-03-10 17:52 | Report Abuse

Hi JT Yeo,

Newbie here. Would like to know where can i get the Cost of Capital (CoC)? Is there a formula for it?
Thanks.

Probability

14,500 posts

Posted by Probability > 2016-03-10 18:36 | Report Abuse

JT Yeo…nice sharing…but as a mental exercise..i would like to present my view:
I think P/E is the standard expectation of the market rather fixed around ~ 10 and the P/B is the variable part based on the ROE = E/B

To put it in a formula:

P/B = (P/E) x 1/ (E/B)
= PE over ROE

i.e using PE of 10, P/B = 10 x ROE…meaning Mcap over Book value is purely dependent on the actual ‘true ROE’…i.e based on the true Earnings.
PE of 10…is basically at that level coz.. the inverse value..i.e, E/P has to be above that minimum level 'the cost of capital of 10'….if the market cost of capital goes higher…you would expect a lower PE.

Now..why some deserve a higher PE?
I think that’s purely due to E-arnings growth…meaning the ‘true ROE’ is way much higher than from its visible history or from the near future… a much higher true ROE will obviously give a much higher current P/E…as the real E is much bigger in the future.

Probability

14,500 posts

Posted by Probability > 2016-03-10 18:38 | Report Abuse

you can actually use the NPV of future E-arnings as and indicator of the true value of the E...to get an idea why some has higher P/(E-present).

Probability

14,500 posts

Posted by Probability > 2016-03-10 19:10 | Report Abuse

Sorry the formula is this:

P/B = (P/E) x (E/B)
= PE X ROE

getting old already..

soojinhou

869 posts

Posted by soojinhou > 2016-03-10 19:25 | Report Abuse

Thank you for the refresher course.

3iii

13,340 posts

Posted by 3iii > 2016-03-10 19:36 | Report Abuse

EV = market value of common stock + market value of preferred equity + minority interest + market value of debt - cash and cash equivalents (investments).

Using EV as a enterprise multiple, you should divide EV by EBITDA.
Enterprise multiple = EV/Ebitda


Prof. Domodaran of NYU, the expert on valuation, stresses on this point relentlessly.


Read more: Enterprise Value (EV) Definition | Investopedia http://www.investopedia.com/terms/e/enterprisevalue.asp#ixzz42UzeH0NG

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