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Price Earning Ratio and Corporate Growth

Info: 5448 words (22 pages) Example Literature Review
Published: 6th Dec 2019

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Tagged: Finance

From the investor point of view the price earning ratio was the most easiest way to judge either the company was producing the good profit or not and people think that if the price earning ratio was increasing so the companies growth was increasing to, but in real have no significant relation with each other, price earning ratio and growth, in past many researches have done study the behavior of growth with different variable like p/e ratio, dividend payout ratio, e/p ratio and many more. In this research p/e ratio used to test relationship between the p/e ratio and growth of a company so this research was to give idea to all investor that there was not a significance relation between these two variables and growth was not dependent to price earning ratio.

The core idea of this study was to find out that was there any correlation between p/e ratio and corporate growth, in context of past several researches it was clear that there was not any relation between p/e ratio and corporate growth in long run, but there was a relation.

The most general measure of how expensive a stock is. The price / earning was equal to market capitalization of a security divided by its profit after tax for a period of 12 months, usually the follow-up period, but sometimes the current period or forward. The value was the same whether the calculation was performed for the entire company or on a basic share.

For example, the price / earning ratio of company with a price of $ 10 per share and earnings per share of $2 was 5. The higher the price / earning ratio, the higher the market was ready to pay for each dollar of annual income. Companies with high price / earning ratios were more than “risky” investments which have low price / earning ratio, and a maximum price / earning ratio indicate high expectations. Comparison of the price / earning ratios was most valuable for firms in the industry. Price earning ratio of last year would be real while price earning ratio for future year and this year might be estimated, but in each case the “p” in the expression was the current price. Companies that were not profitable do not have a price / earning at all. Price earning ratio also called earning multiplier.

In past there were so many work on price earning ratio some of these were Nicholas Molodovsky (1953) discussed pe ratio in his paper A Theory of Price-Earnings Ratios, Lewis C. Wilcoxen (1955) in The Price-Earnings-Variable Characteristicsm, M. j. gorden (1959) in his paper Dividends, Earnings, and Stock Prices, Sanford L. Margoshes (1960) Price Earnings Ratio in Financial Analysis …. Its Use and Abuse, Joseph E. Murphy, Jr. and Harold W. Stevenson (1967) in Price Earnings Ratios and Future Growth of Earnings and Dividends, Earl M. Foster (1970) in Price-Earnings Ratio and Corporate Growth and Price-Earnings Ratio and Corporate Growth: A Revision, William Beaver and Dale Morse (1978) in What Determines Price-Earnings Ratios, Darryl Craig, Glenn Johnson, Maurice Joy (1987) in Accounting Methods and P E Ratios, Walter R. Good (1991) in his paper When were Price Earnings Ratios Too High Or Too Low, Patricia M. Fairfield (1994) in PE, PB and the Present Value of Future Dividends, W. Edward Bell (1958) in his paper, Martin L. Leibowitz and Stanley Kogelman (1990), Martin L. Leibowitz and Stanley Kogelman (1994),Martin L. Leibowitz (2002) The Levered P-E Ratio, Lewis C. Wilcoxen (1955) The Price-Earnings-Variable, and James D. McWilliams (1966) Prices, Earnings and P-E Ratios

Economic growth was a expression used to indicate the raise of per capita gross domestic product (gdp) or other measure of cumulative income. It was over and over again measured as the rate of change in gdp. Economic growth refers simply to the quantity of goods and services produced

There were many ways to find out the growth of any firm from which some techniques were dividend discount model, sustainable growth rate, assets revaluation, profitability, earning growth but in this research the concept of sales growth used to find out the growth of particular company.

Sales growth rate can be term as the percentage change in the value of total sales. Sales growth was the main indicator of gauging the company’s financial growth or the growth through the sale.

Sales growth was a valid predictor for computing the growth of any manufacturing companies because the growth of manufacturing companies were totally based on the total sales.

In past there were lot of work on growth with different variables from which some were Sanford l. Margoshes (1960) discuss both e/p and growth in price/earnings ratio in financial analysis: …. Its use and abuse, Joseph e. Murphy, Manown Kisor, Jr. (1964) in his paper The Financial Aspects of Growth, Jr. And Harold w. Stevenson (1967) in his research paper price/earnings ratios and future growth of earnings and dividends, changes henry a. Latane, Donald l. Tuttle, charles p. Jones (1969) in e/p ratios v. Changes in earnings in forecasting future price, Manown kisor, jr. And van a. Messner (1969) in the research the filter approach and earnings forecasts, earl m. Foster in (1970), model James a. Gentry and Stephen a. Pyhrr (1973) in simulating an eps growth, martin l. Leibowitz and Stanley Kogelman (1994) in his paper the growth illusion: the p/e ‘cost’ of earnings growth, and Joseph E. Murphy, Jr. (1966)in his paper Relative Growth of Earnings per Share Past and Future

Cement was one of the major industries of Pakistan. Pakistan was wealthy in cement raw material. At present many cement plants were operating in personal sector. Pakistan cement industry has huge prospective for export of cement to neighboring countries like indian market, middil east market and Russian states. There has been a strong growth of cement demand seen both in local and exports market during the previous decade.

This research was beneficial for people who want to invest in cement sector; more over it help every person who wants to buy shears of cement industry. This study was helpful for the economist, consult it for watching the state of the sector and also give views about to improve the situation of sector.

This study examines the relation between earning price ratio and corporate growth. To determine the relation between earning price ratio and growth, eps and per share market value had been used for calculating the e/p ratio and earning growth was used to calculate growth of firm by taking difference of current eps and previous eps then divide the result from previous eps, correlation technique and regression analysis have been applied in order to determine the relationship. The companies which were included in this study were from the cement sector and testing on hypothesis had been done on the data from 2003 to 2008.

Research Objective

The objective was to determine that price earning ratio was a valid predictor of growth.

The map of this research was as follows: In section II there was full description of variable used in research. In section III data used in the research, that was the testable proposition of the price earning ratio to forecast growth and methodology, was evaluated. Empirical outcome were provided in section IV and section V contained concludes


Robert shiller’s field of the S&P compound real p / e ratio and interest rates (1871-2008), the irrational exuberance. The foreword to this edition, Shiller informs that “the stock market has not fallen to historic levels: the p / e ratio as I describe it in this book was to this day [2005], in the mid 20 much higher than the historical average. People were still too great self-belief in the markets and have too much strong conviction that were aware of twist in the investments had sooner or later become wealthy, and not made preparations for possible bad results conservative.

Price earning ratio of a share was a gauge of the paid price per share on net yearly income or per share earnings earned by the company. It was a financial ratio used for evaluation: one more price earning ratio means that investors had to pay extra for every unit of net profits, so that the stock was more expensive than one with low price earning. Price earning ratio has units of years, which can be interpreted as: years of income to repay the purchase price; does not take into account the tvm (time value of money). In other terms, indicates the price earning, the current demand of investors for a stock company. The pe ratio was known as inverse performance gains. The earning price was an estimate of projected performance gain holding the stock, if one admits certain restrictive hypothesis (a debate of these hypothesis might be found here).


There were different price ratios used, all of which were defined as follows:

The stock price in the numerator was the market worth for a single share of stock. The eps in the denominator depends on the price earning

Trailing P/E” or “P/E ttm”

Eps can be define as net income of the company for the last 12 months, period, broken down total outstanding shares. It was the most general sense price earning; if no other criterion was specified. The monthly benefit for individual contractors was not available, then the last four quarterly reports on incomes were used and eps were updated quarterly.

Trailing P/E from continued operations

The final price to earnings from ongoing operations; as an alternative of net income, use the operating income, which eliminates earnings from suspended operations, unusual items.

Estimated P/E

As a substitute of net income, use the estimated net revenue over the next 12 months. The estimates were usually derived from the average of the small group of analysts (note the choice was rarely mentioned).

Price earning ratio may alternatively be calculated by dividing the market value of the company by total annual income.

For example, if the stock was trading $ 24, and earnings per share for the last 12 months was $ 3, so the stock price earning ratio of 24 / 3 or 8 in other words, the buyer pays $ 8 stocks for every dollar of revenue. Companies with losses (negative) or non-profit was an undefined price earning usually referred to not apply or at times, however, a / negative price earning can be visible.

By putting side by side prices and per share earning for a firm, you can analyze the market value of a firm and its stocks relative to income that actually generates. Stocks higher (and / or safer) earnings growth forecasts tend to be a higher price earning and have lower (and / or more risky) profit growth, in most cases less than price earning. Investors can use ratio of price earning to compare the stocks’ value: if a stock has a price earning twice a second stock, ceteris paribus (including earnings growth rate), it was an investment fewer attractive. Firms were hardly ever equal, but, assessments between sectors, firms and periods can be ambiguous.

Since 1900, the average price earning 500 ranged between 4.78 Dec 1920 to 44.20 in December 1999, where an average of 15. The average price earning depends on, among other factors, the expected growth of profits revenue was expected to stabilize inflation expectations and performance of competing investments. For example, when the us treasury department for the production of high returns, investors pay less to the eps and price earning fall.

Price/earnings ratio, because the twenty-year forecast of revenue the concept was ploted by Robert Shiller. The horizontal display the actual price earnings ratio of composite stock price index, calculated as irrational exuberance (inflation adjusted price divided by profit before ten-year average adjusted for inflation). Vertical axis demonstrates the geometric mean real yearly return on putting in the composite stock price index, reinvesting dividends and the sale of twenty years later. Data for different periods of twenty years were color coded as indicated in the key. See also ten years ago. Shiller, this plan; verifies that long-term investors, investors who gives money for an investment of whole ten years, did glowing when prices were lesser relative to incomes at the starting of the decade. Longer investors’ term individually would be wise to reduce the coverage to the stock market when it was elevated as it has recently been entering the market when it was weak.

Determining share prices

Stocks prices in a publicly traded firm were evaluated by market exchange, and thus depend upon the prospect of sellers and buyers. Between these are:

The firm’s future and current presentation, including possible growth;

Perceived risk mutually with risk due to elevated leverage;

Outlooks for firms of this kind, the market sector

By dividing the price of a share in Profit firm by per share of company, you arrive at price earning ratio. If the earnings per share move in proportion to the relationship during the market remains the same. But if the stock price appreciation and earnings stay the similar or go down, price earning increases. The earnings figures used were the latest; although this figure may be outdated and do not essentially reflect the present position of the firm. It was often cited as a; follow price earning as it was to take the benefit of the previous four quarters.

Other connected measures

Forward price earning was using the estimated forward earnings for twelve months.

Price earning 10 used the average wage of the last 10 years. Consider the average level of earnings within 20 years remains essentially constant, to reduce price earning10 using data noise.

Price earning ratio linked to the net asset value. Similar measure can be defined as real estate, case-Shiller index.

Peg ratio was calculated by dividing the price earning ratio of annual growth in profits. It was seen as a kind of standardization, as more growth leads to higher price earning ratio was similar to the level of societal values and EV / EBITDA enterprise by EBITDA

Growth opportunities of Present value

There were another alternative way to value stocks. The present value was the growth potential was calculated to discover the dissimilarity among the equity price with the continued growth and reasonable price, without growth.

Earnings yield

The opposite result of price earning was the earning yield (e/p), earnings yield was quoted in percentage, and was useful for comparing stocks, sector or market valuation relating to the debt. Earnings yield was also the cost of listed companies raising capital by granting the extension of storage.

Price dividend ratio

Listed companies often made periodic quarterly or annual payments to the shareholders, owners in straight proportion to the total number of shares. Under U.S. Law, these payments can be made from current income or reserves. The firm had to decide on the total payment, and it was divided by the total number of shares was the resultant bonus was an amount of cash per share.

Since price earning ratio was the ratio of price to earnings, the Price/Dividend was the ratio of price to dividend.

Dividend yield

Dividend yield was dividend paid dividends during the last year divided by the present stock price: it was the inverse of the price dividend payout ratio.

If a stock paid $ 5 per share, dividends paid to shareholders last year and the price was currently $ 50, which has a dividend yield of 10%.

Historically severely high price earning ratio (as 100 times), a stock has zero (0.0%) or insignificant dividend yield. With a price earning ratio over 100 times, and assuming a portion of income paid in dividends, it would take more than a century to recover the purchase price. These stocks were extremely overvalued, unless a very strong revenue growth in the coming years was projected.

Linked between measures

Some of these measures were linked to each other given earnings, dividend, and price, there were 6 probable ratios, which come in inverse pairs

P/e ratio and earnings yield were inverses;

P/d ratio and dividend yield were inverses;

Dividend Payout Ratio was equal to dividend divided by earning per share, while the inverse was dividend cover which was equal to earning per share divided by dividend.

Following were linked by the following equations:

Price earning was equal to price dividend multiply by dividend payout ratio and price dividend was equal to price earning ratio multiply by dividend cover;

Taking inverse, earning price ratio was equal to dividend yield multiply by dividend cover and dividend yield was equal to earnings yield multiply by dividend payout ratio.


In the USA one of its p / e 1900-2005 were 14 (or 16, depending on the geometric mean and arithmetic average, to be used on average). Simplified interpretation can be inferred that it takes about 14 years his income back to the price paid for the [stock does not include any income, resettlement of revenues].

Typically, stocks of highly profitable growth were a higher p / e values. The above example, stocks, trading $ 24 per share you can expect to earn $ 6 per share next year. Then the forward price earning ratio was $ 24 / 6 = 4 so you pay $ 4 for every dollar gains, which makes the position more attractive than it was last year.

The price earning absolutely incorporates the apparent risk of a given firm’s future earnings. For a share purchaser, this risk includes the chance of bankruptcy. Assuming the result of leverage was affirmative, the earnings for extremely leveraged firms had also be higher. In standard, the price earning incorporates this information, and different price earnings can be reflecting the structure of the balance sheet.

Differences on the standard trailing and onward price earnings were general. Generally, alternative price earning measures alternate different gauges of earnings, such as rolling mean over longer period of time (to “smooth” unstable earnings, for instance), or “corrected” income figures that leave out certain unusual proceedings or one off losses or gains. These definitions may not be identical.

Various interpretations of a particular price gains were possible, and below the timeline were merely illustrative and can be a guide, the current price earnings compared with real interest rates (see model the fed):


A firm has no gain profits. By meeting, firms with losses were generally regarded as having an income of indefinite price, price earnings, even if a negative can be mathematically determined


Or was undervalued stock or profits of the company were thought to decline. Moreover, current earnings may be materially higher or historical trends of society has benefited from the sale of assets.

10 to 17

For many companies winning in this range can be considered fair value

17 to 25

Whether the stock was overrated or the benefit of the firm has amplified since the last earnings figure was available. The stock can be also a growth stock with earnings projected to increase significantly in the upcoming.

25 +

A firm whose stocks have a very lofty price earning may have a high level of future earnings growth or the stock may be subject to approximated bubble.

It was not generally enough to appear at the price of a company deserves and to define its role. In general, the analyst examines the company price to earn field compared to the company, the company was the global market (eg, S&P 500 if quoted in USA stock exchange). Sites as Reuters suggest these associations in a table. Example spy often the comparison was also made up of quarterly and annual data. Only with respect to the industrial sector and the market could gain an analyst that the price was high or low differences mentioned above (ie, undervaluation, over the value of fair value, etc.).

Using discounted cash flows, the effect of earnings growth and inflation estimated. The online calculator on money chimp evaluates the fair price earning, stable use of past rates of earnings growth of 3.8 and the post war s&p 500 return of 11% (as well as the 4% price rises) as a discount rate, just price earning was obtained in 14.42. A growing population of 10% for the next five years have a fair price earning of 18.65.

The Market P/E

To compute the price earning ratio of a market index like the S&P 500, it was not necessary to consider properly the “simple mean” price earnings of all the components of stocks. The ideal and exact method was to compute the weighted average. In this case, the cap of the respective underlying shares of the market (price multiplied by the number of shares outstanding) was summed to offer the total worth in terms of market capitalization for the entire market index. The same approach was used for each share of net earnings. In this case, the total net profit was calculated, which gives the total earnings for the index of the market. The final step was the allocation of entire market capitalization by the entire earnings to give to the market price earning ratio. The grounds for grounds the weighted average methodology rather than “simple” mean can finest was explained by the fact that slighter components have less impact on the complete index.

For example, if market index was based of firms X and Y, which both have the similar price earning ratio (so the price earning ratio of market index have to be same as well) but the cap of X was 9 times better then Y, then a percentage fall in per share earning in Y smaller effect on the market index at the equivalent percentage fall in per share earning of X. One easiest way to observing a market index price earning ratio to see the ratio of price earning an ETF that tracks the index to find.

A shift that was often used was to eliminate companies with negative returns of the sample – particularly when considering the sub-indices with a small number of shares, where companies with annual revenues of negative numbers twist.

In the long term stocks, Jeremy Siegel says that the earning yield (the reciprocal of price earning ratio) was a good gauge of market performance on the long term. The average price earning ratio for the last 130 years was 12.1 (which was 8.3% earnings yield).


• Accuracy and framework

In practice, decisions have to be made as to the exact original data used to specify the calculation.

Does the current market worth more exactly value the association?

How income was to be computed, and for how long? How to compute the total capitalization?

Can this value be trusted?

What were the prospects for revenue and profit growth over the period, it was investing around?

Are there special one-time costs, which artificially minored (or artificially high) income in the computation and costs cause a decline in the share price or it had been ignored?

Were these blames truly one timer, or if the company was trying to conceive to manipulate it?

What kind of price earning ratio were the market leading companies alike, and the price earning ratio of the total market?

Is the price earning ratios an accurate measurement?

History vs. Projected Earnings

One must distinguish between the intrinsic price earning and the way of calculating price earning ratio. Forecasts fundamental or intrinsic price earning examines earnings forecast. This has done in the above analogy. In fact, the calculated price earning for the last 12 months corporate profits. Using past earnings demonstrates a temporal disparity, but it was believed that under this disparity was better than using future profits, since future profits estimates were disreputably inaccurate and vulnerable to deliberate manipulation.

On the supplementary hand, just because a stock was listed at a low intrinsic price earning was not a gauge that the stock was undervalued. A share can be operating at a low price earning, as investors were not as much of optimistic about future profits of the shares. So a way to get a fair comparison among stocks, using the initial price earning ratio. This primary price earning ratio based on the expected profits over the years next to a discount computation was applied.

The Price earning ratio Concept in Business Culture

The price earning of a company was a high priority for management of many firms and industries. This was for the reason that management was mainly paid with the firm’s stock (a form of a payment, which supposed to be lining up the interests of management and the interests of other shareholders) in context to increase the share price. The share price can in two ways:

Either by increasing earning.

Improving profitability improved by a multiple that the market allocates profits.

As mentioned above, a higher price earning ratio was the result of a stable advantage that a company’s profits grow over time (i.e. increase were allowed, for investor’s peace of mind).The efforts of management to convince investors that the companies have had a sustainable advantage a profound impact on business:

The main motivation for building corporations was to diversify the income, so go up steadily over time.

The selection of companies that were strengthened or were closed or sold within these corporations were often made on the basis of its perceived instability, despite of the absolute level of profits and profit margins

One of the main types of financial fraud, “accounting slush fund” (hiding surplus earnings in good years to wrap losses in bend years), was designed to generate the reflection that the company always gradually but steadily increases profits, with the aim to boost the price earning ratio.

These and a lot of further actions used by firms to structure themselves to be apparent as commanding a elevated price earning ratio can seem gut feeling to some, because while that might lessen the absolute level of earnings were designed to increase the share price. Thus, in this state of affairs, maximizing the share price acts as a perverse incentive.

Mark T. Bradshaw (2004) discussed in research paper that whether valuation estimates were on the earnings expectations of analysts’ forecasts in line with the recommendations for action. Because earnings forecasts were related to the value and recommendations reflect the opinions of analysts value against the current price profit forecasts and recommendations for action were linked in a predictable way. I consider four possible valuation models such as earnings forecasts and stock recommendations were associated. These models were equipped with two specifications of the residual income-model, a price earnings growth (PEG) model, and analysts forecast earnings growth in the long run. The results provide little evidence that the recommendations of the analysts of the model specification or passive income were explained. However, the PEG-model and analyst projections for earnings growth were to explain long-term stock recommendations of analysts. The relationship between pricing models and future performance was also investigated. Analysts forecast earnings growth in the long run have the greatest explanatory power of recommendations for action, but the investment strategies on these forecasts have the slightest connection with future excess returns. Overall, there was evidence that the recommendations of the analysts more correlated with heuristic valuation models with pv models, and investors’ buy-and-hold returns would be higher based on models that incorporate the present value of earnings expectations of analysts’ forecasts of the recommendations of analysts.

In 1377, the Arabian economic theorist ibn khaldun gave one of the earlier images of financial growth in his renowned muqaddimah (recognized as prolegomena in the western world):

“When society [population] increases, the available manual labor yet again increases. In turn, lavishness again increases in correspondence with the growing profit, and the customs and desires of luxury amplify. Crafts were formed to obtain luxury goods. The value rose, and, as an effect, profits were again grow in the town. Production there was flourishing even further than before. And so it goes among the second and third boost. All the supplementary labor serves lavishness and wealth, in difference to the original labor that served the essential of life.”

In the early modern period, a group of people in western European states developed the plan that economies could “grow up”, that is; produce a superior economic surplus which could be expended on somewhat other than mere survival. This excess could then be used for utilization, warfare, or civic and holy projects. The preceding view was that only growing either population or tax rates could produce more excess money for the country.

Currently it was usually known that economic growth also keep in touch to a process of repeated rapid substitute and restructuring of human activities made possible by investment provoked to made the most of returns. This exponential development of our self-prepared life-support and cultural structures was extraordinarily creative and elastic, but highly changeable in many ways. As there were complexities in modeling compound self systematize systems, various hard work to model the extended term development of economies have formed varied results.

During much of the “mercantilist” era, growth was observed as connecting a raise in the overall amount of specie that was moving average like wise gold and silver, under the controlled condition. This “bullionist” assumption led to guiding principle to force trade from side to side a particular situation, the acquirement of colonies to provide lesser priced raw materials which then manufactured and did business.

Afterward, such trade strategies were acceptable instead merely in conditions of encouraging domestic trade as well as industry. Under this structure high duties were erected to permit manufacturers to establish factories. Domestic markets would then reimburse the permanent costs of capital growth, and it was permitted to export overseas, undercutting the costs of manufactured goods somewhere else. Once rivalry from abroad was uninvolved, prices could then be enlarged to recover the costs of founding the business.

Under this assumption of growth, one policy tried to promote growth was to endowment monopolies, which would give an enticement for an individual to utilize a market or reserve, sure that he would build all of the earnings when all other extra-national players were turned out of business. The East Indian Company of Dutch and the East Indian Company of BRITAIN were huge examples of such state granted trade monopolies.

In this era the vision was that the growth can improved through beneficial business in which specie would run in to the state, but to treaty with other countries on alike conditions was unfavorable. It was anxious that mercantilism was not only a issue of restricting trade. With in a country, it intended breaking down trade barriers, construction of fresh roads, and eliminating local toll stands, all of which extended markets. This match was to the systematization of clout in the hands of the peak (or “absolutism”). This process helped to form the existing nation state in Western Europe.

Globally, mercantilism lead to a confront: growth was exploit in the course of trade, but to trade with further nations on the equal requisites was unfavorable.

Long-term growth and short-term stabilization

Economists sketch a contrast between short term stabilization and long-term expansion. The theme of economic expansion was chiefly associated with the long run. The short run difference of financial growt

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