I have a question regarding calculating the effect of growth en roic on the P/E ratio.
I can not post the link from the article here, but you can find it on Google: all pe’s are not created equal. It is an article from McKinsey.
It is about exhibit 1. I figured out how to calculate the PE ratio for Returns Inc. ROIC = 35%, growth = 5%, cost of capital = 10% and PE is 17.
ROIC/GROWTH RATE = 5/35 = 0,14. So 0,86 is distributable cash. cost of capital is 10 and growth rate is 5. 0,10 - 0,05 = 0,05. 0,86/0,05 = 17.
But when I want to do the same for Growth Inc there is the problem that the growth is higher than the cost of capital and therefore I get a negative number if i want to substract the growth from cost of capital. Growth Inc ROIC = 14%, growth = 13% cost of capital = 10% and PE is 17
Obviously I am doing something wrong, any wizzkids who can help me figure this out?
Thanks in advance.