Can someone please explain why is the implied company P/E negatively related to index growth rate and index dividend yield? Schweser’s Book 4 doesn’t provide an explanation or at least I can’t find it… Thanks in advance!
Index up, earnings up, P/E down - Negatively related Increase in Dividends, Less retention, ROE decrease, price falls, P/E falls… …I suppose!! Anish
I think its that small study session in SS 12 … ln (PE/PE) = T ln ((1 + g + d)/(1 + g + d)) Where the ratios are between the firm and the index. so the P/E of the firm is negatively related to the growth and dividends.of the index T here is the number of time periods the firm can sustain its growth above the index benchmark. Does anyone remember the derivation. i know that there is some kind of approximation that was made to reach this equation.
Thanks for the replies! With the above formula I can see why it would be negatively related to the index, but intuitively… if a company has the same risks as its index and the same growth prospects, why would the P/E be positively related to its growth rate, but not to the index growth rate?..
I think that is because we are not looking at absolutes here. The firm’s P/E is benchmarked against the index (As you can see from the ratios). So if g and d of the firm remain the same while g and d of the index increase would mean P/E of the firm decreses ‘relative’ to the index.
Got it!! You’re right, I completely forgot to look at the relativity of the two. Thanks eros79.