On page 307 (and followed by an example on 308) of Vol 4 CFA text, the equations for trailing and leading P/E multiples are given using the DDM gordon growth model. Leading P/E = 1-b/r-g Trailing P/E = (1-b)(1+g)/r-g My question is…shouldn’t those formulas be reverse? Shouldn’t the leading P/E multiple be the current dividend payout ratio (which is defined as 1-b) multiplied by 1+g the growth rate? Then the trailing P/E should be the current payout ratio without the growth rate multiplied into it? It doesn’t make sense to me. I would think the leading ratio would be the formula with the growth rate mlutiplied into the payout ratio to represent future growth of the upcoming year. Any help?
remember that next year’s earnings (leading) = this year’s earnings * (1+g) and when you do Dividend Discount Model you do D1/(r-g) and D1 = d0(1+g) = eo * (1-b) * (1+g) so P/E0 = (1-b)(1+g)/(r-g) and P/E1 = (1-b)/(r-g) so
Though anit-intuitive, they are the correct formulas.
hmm ya it appears to be right. just doesnt make sense when looked at it from the formulas only standpoint
i completely agree. but you cant get intuitive on all the questions unfortunately. they way i remember it was that leading is FIRST so its just the Div payment/k-g, then trailing is second so its div payment(1+g)/k-g. Looking at the math, it appears you also need to realize the difference between the both is nothing more than (1+g). There was a question in Schweser that asked for the Trailing, but only provided you the info to compute the Leading, and you had to use the growth rate to apply to the computed leading PE to get the trailing PE.
Earnings in t+1 will be: (1+G)*Earnings in t. Hence P/E at t+1 < P/E at t by a factor of 1+g