Earnings Multiplier for Stock Market Series

Explanation

The earnings multiplier is found as 12.33 for this series, and the value of the series is computed as $45.

Estimating the earnings multiplier for a stock market series requires the estimation of each of the following components:

1. The dividend payout ratio.

2. The required rate of return on common stock in the country/region/industry/sector being analyzed.

3. The expected growth rate of dividends for the stocks in the country/region/industry/sector being analyzed.

Once values for each of these components have been determined, they are imputed into the following formula: {P/E = [D/E / (k - g)]}. Where: P/E = the earnings multiplier, or Price-to-Earnings ratio, D/E = the dividend payout ratio at t1, k = the required rate of return, and g = the anticipated growth rate of dividends.

In this example, all of the necessary information has been provided. However, before the earnings multiplier can be determined, the dividend payout ratio must be found by manipulating the retention rate. Remember that the retention rate is equal to (1 - the dividend payout ratio), just as the dividend payout ratio is found as

(1 - the retention rate). By this logic, the dividend payout ratio and the retention rate must always add up to one. The dividend payout ratio for this series is found as (1 - 0.63) = 0.37.

Now that the dividend payout ratio has been determined, the calculation of the earnings multiplier is shown below: {P/E = [0.37 / (0.13 - 0.10)] = 12.33}. Notice that it is the anticipated growth rate of dividends that is used in this equation, not the anticipated growth rate in earnings.

Once the earnings multiplier has been determined, the value of this stock market series can be found by multiplying the EPS figure by the earnings multiplier. This will lead to a value of $45 for this stock market series, or 12.33 x 3.65 = $45.02.