Expected Earnings Multiplier

A

To determine the earnings multiplier (i.e. the price-to-earnings ratio) for an individual company, use the following formula:

P/E = [(d1 / e1) / (k - g)]

Where: P/E = the earnings multiplier, d1 / e1 = the dividend payout ratio at t1, k = the required rate of return, and g = the anticipated future growth rate.

In this example, all of the necessary information has been provided, but some rearranging is necessary. Specifically, the dividend payout ratio must be determined. This figure is found as follows:

Dividend payout ratio = [$2.10 / $2.91] = 0.721649, or 72.16%

Now that the dividend payout ratio has been determined, we can solve for the appropriate earnings multiplier. The calculation of this figure is found as follows:

P/E = [0.7216 / (0.105 - 0.075)] = 24.05

This is a relatively high multiple for a utility company growing by 7.5% per year. (Although this figure is not completely beyond the realm of reason.) An analyst examining this stock would likely regard this earnings multiplier with some degree of caution. Further analysis would probably be warranted.