What’s the P/B if ROE = 10%, required rate of return on common equity (r_ce) = 9%, and earnings growth = 5%?

If you have memorized the formula, it’s quite easy, but you should be able to figure it out from GGM. With so many fomulas, it is quite possible you won’t always be able to recall a formula on command.

My point exactly…we think a formula is easy and we try memorize it, only to find later that it looks like many other formulas, or you you forget whether it was r or g, etc.

Go back to basics:

P0 = D1/(r-g) is the grand daddy of many formulas.

Recall that D1 = E1(1-b)

Divide both sides by B, and you get P/B on the left side.

Then E1/B on the right side is ROE… a little algebra will get you P/B = (ROE-g) / (r-g)

kys916, show that P/B = (ROE-g) / (r-g) = 1 + (ROE - r)/(r-g)…that’s your algebra quiz.

Note this last version is useful as it shows the relationship between ROE and r. You can see that:

P/B = 1 + (ROE - r)/(r-g) … multiply, both sides by B:

P = B + (ROE - r)/(r-g) * B

Here is an important concept: The value of the stock is current book value + the excess return above the required return that you get from the company, multiplied by the book value (using GGM in the last part).