Estimating Earnings Multiplier: Techniques

Explanation

More than one of these answers is correct. Specifically, the "direction of change" and the "specific estimate" are methods of forecasting the earnings multiplier of a stock market series and "microanalysis" and "macroanalysis" are used to forecast the earnings multiplier for an industry.

When estimating the earnings multiplier for an industry, there are two common methods - the "direction of change" and the "specific estimate" approaches. The direction of change approach begins with the present earnings multiplier for a stock market series and seeks to estimate both the amount and direction of any change based upon changes in the components of the P/E ratio - the required rate of return, the anticipated growth rate of dividends, and the dividend payout ratio.

This approach is contrasted by the specific estimate approach, which involves the estimation of a specific value for the earnings multiplier based on a series of projections for values of the components of the earnings multiplier components. When using this approach, analysts commonly confine their estimates to a series of scenarios, typically a best case, worst case, and base case scenario.

There are two common methods for estimating the earnings multiplier for an industry - macroanalysis and microanalysis. Macroanalysis involves an examination of the relationship between the earnings multiplier for an industry and the earnings multiplier for the market. Microanalysis involves an estimation of the specific variables that influence the earnings multiplier, including the required rate of return, the estimated growth rate, and the dividend payout ratio. While the top down and bottom up method are similar to macroanalysis and microanalysis, respectively, they do not represent the best possible answer.

Specifically, the top-down and bottom up approaches are typically used to identify investment opportunities, not for the estimation of an industry earnings multiplier.