The relationships between the price-earnings ratio and selected risk and return and valuation models

[摘要] ENGLISH ABSTRACT:The price-earnings ratio is one of a series of benchmarks developed after theGreat Depression, to measure the fair value of shares on a relative basis. Itoriginated from the idea that investors buy the earnings of a company and thatthe price-earnings ratio provides a consensus indication of the future growthpotential of a company. Therefore, the price-earnings ratio is a rating of acompany's future profitability.The price-earnings ratio developed, over the years, firstly, into an indicator ofthe relative risk associated with a company as the market anomaliesassociated with the ratio were investigated and clarified, and the theoreticalbackground of the ratio integrated with the portfolio theory. It is now clear thatthe price-earnings ratio can be a useful indicator of the risk associated with aninvestment and the uncertainty associated with the duration of the growthphase of a company.Secondly, the price-earnings ratio is also a growth and valuation model with atheoretical background that can be linked to popular dividend discount modelsand the growth opportunities approach to investment valuation. With the useof the price-earnings ratio it is easy to visualise the relative profitability and thetotal investment required to raise a company's rating of future profitability.This simplicity allows one the opportunity to evaluate the reasonableness andlikelihood of the investment reaching its projected potential profit targets. Lastly, as a result of accounting changes and the different accounting rules inforce today, the price-earnings ratio also assists in the identification andelimination of the effects of accounting on investment decisions.It is apparent that the price-earnings ratio possesses the capabilities to assistinvestors significantly with the analysis of investment opportunities.

[发布机构] Stellenbosch University