Price/Earnings (P/E) Multiples/Ratio

The P/E ratio/multiple reflects the amount investors are willing to pay for each rupee of earnings. Symbolically,


where 1 - b = dividend pay ratio
r = required rate of return
ROE x b = expected growth rate

The earnings per share (EPS) of the firm are multiplied by the average P/E ratio for the industry to estimate the value of the firm on the assumption that the investors value the earnings of a given firm in the same manner as they do the "average" firm in the industry. Assuming on the basis of an analysis of historical earnings trends and expected economic and industry conditions, the Alert Ltd would earn Rs 15 per share next year, and average P/E ratio for the firms in the industry is 10, value of its share = Rs 15 x 10 = Rs 150.

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