FNCE30011 · Essentials Of Corporate Valuation
Valuation using PE Multiples
A multiple prices an asset by reference to a comparable one: PE is the price–earnings ratio, an equity multiple (equity value ÷ equity earnings), quoted trailing (last year's earnings) or forward (next year's). Its conceptual core is the FCFE-framework reading: a no-growth firm has PE = 1/ke, and a growth firm has PE = 1/ke + G/e1 — so a PE encodes time value, risk and growth all at once. The earnings base you apply it to should be future maintainable earnings (e): normalised, with one-offs and surplus income stripped and no growth allowance baked in — because growth already lives in the multiple. Choosing comparators is where judgement enters: they must be genuinely like-with-like, and because PE is computed after interest and after tax, it only compares cleanly when leverage and tax positions match. A final wrinkle is the control premium — transaction (whole-company) multiples sit above stock-market (minority-stake) multiples, so you adjust depending on whether you are pricing a controlling stake or a parcel of shares.
What this chapter covers
- 017.1 What a multiple is; PE as an equity multiple, trailing vs forward
- 027.2 The FCFE reading: no-growth PE = 1/ke, growth PE = 1/ke + G/e1
- 037.3 What a PE encodes — time value, risk and growth in one number
- 047.4 Future maintainable earnings: normalise, strip one-offs, no growth allowance
- 057.5 Choosing comparators; why PE only compares like-with-like at the equity level
- 067.6 Transaction vs stock-market multiples and the control premium
Worked example: sense-check a quoted PE
- +1Identify. Use the FCFE decomposition PE = 1/ke + G/e1 to split the multiple into time-value-of-money and growth.
- +1No-growth component. 1/ke = 1/0.09 = 11.11 — what the PE would be with no growth.
- +1Growth component. PE − 1/ke = 15 − 11.11 = 3.89 = G/e1, so G = 3.89 × 4.00 = $15.56 per share of value from growth.
- +1Interpret. About a quarter of the PE (3.89 of 15) is growth; the market is paying for expansion beyond the no-growth 11.11. A higher ke or weaker growth would compress the multiple.
Key terms
- Price-earnings (PE) multiple
- Equity value ÷ equity earnings (or price ÷ EPS) — an equity multiple computed after interest and after tax. Trailing uses last year's earnings; forward uses next year's.
- FCFE reading of PE
- No-growth PE = 1/ke; growth PE = 1/ke + G/e1, where G is the present value of growth per share. A PE therefore encodes time value, risk (via ke) and growth simultaneously.
- Future maintainable earnings (e)
- Normalised, sustainable earnings — one-offs and surplus income stripped, with no growth allowance, because growth is already captured in the multiple. The base you multiply by the PE.
- Like-with-like comparison
- PE only compares cleanly when comparators share the target's leverage and tax position, because PE is struck after interest and tax. Mismatched leverage distorts the equity multiple — the cue to climb to an enterprise multiple.
- Control premium
- The extra value of a controlling stake. Transaction (whole-company) multiples exceed stock-market (minority) multiples by this premium, so you adjust depending on whether you are pricing control or a minority parcel.
Valuation using PE Multiples FAQ
Why does a no-growth firm have PE = 1/ke?
A no-growth firm pays out all its earnings, so its equity is a level perpetuity of e per share, worth e/ke. Dividing that value by earnings e gives PE = 1/ke. The intuition: with no growth, the PE is just the reciprocal of the required return — a 9% cost of equity implies a no-growth PE of about 11. Anything above that reflects the market pricing in growth.
Should I add growth to the earnings base when applying a PE?
No — that double-counts growth. The PE already encodes growth (the G/e1 term), so the earnings you multiply by it should be future maintainable earnings: normalised, one-offs and surplus income removed, with no growth allowance. Baking growth into both the multiple and the base inflates the valuation.
When does a PE comparison break down?
PE is an equity multiple struck after interest and after tax, so it is distorted by leverage and the tax position. Two firms with identical operations but different debt will trade on different PEs even though the businesses are alike. When the comparators' leverage does not match the target's, PE stops being like-with-like — the signal to move up to an enterprise multiple (EV/EBIT, EV/EBITDA) that is computed before interest.
Why are transaction multiples higher than stock-market multiples?
A transaction multiple prices a whole company (a controlling stake), which carries the value of control — the ability to change strategy, capital structure or management. A stock-market multiple prices a minority parcel that cannot exercise control. The gap is the control premium, so you pick the right benchmark for what you are valuing: a controlling acquisition uses transaction multiples, a small holding uses market multiples.
Exam move
Carry the FCFE decomposition PE = 1/ke + G/e1 on your A4 — it is the conceptual heart of the chapter and turns a quoted multiple into testable economics. Practise both directions: split a given PE into no-growth and growth, and build a PE from ke and a growth assumption. Always apply a multiple to future maintainable earnings (normalised, no growth allowance) so you do not double-count growth. And keep two judgement calls sharp: PE only compares like-with-like when leverage and tax match (otherwise climb to an enterprise multiple), and transaction multiples carry a control premium over market multiples.
