The P/E Earnings Multiplier Explained | CFA Level 1 Study Guide

The P/E Earnings Multiplier

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Question

The P/E earnings multiplier can be set equal to

Answers

A. the required rate of return minus the dividend growth rate, divided by the expected dividend payout ratio.

B. next year's dividend divided by the spread between the required rate of return and the dividend growth rate.

C. the spread between the required rate of return and the dividend growth rate, divided by next year's dividend.

D. the expected dividend payout ratio, divided by the required rate of return minus the dividend growth rate.

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Explanations

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A. B. C. D.

The earnings multiplier, which is the basis for a method of valuing stocks, is also known as the price / earnings (P/E) ratio. The infinite period Dividend Discount

Model claims that the current price of a common stock is equal to D1 / (k - g), where D1 is next period's (most often next year's) dividend, k is the required rate of return, and g is the growth rate of dividends. If we divide both sides of the infinite period Dividend Discount Model equation by expected earnings during the next

12 months, we get P/E = (D1/E) / (k - g).

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