Value Creation & Price Earnings Ratio (PER)
We are now going to relate ratio (q) of value creation with the PER. The PER is equal to the market value distributed by the benefits (PER = MV/CV) if we clear MV, we are left with MV = CV x q. we also know due to equation 3, that ROE = B/CV and clearing (B) we obtain B = ROE x CV. We will substitute these examples in the PER formula:
PER = MV over B = CV x q over ROE x CV = q over ROE = ROE – g over K – g x 1 over ROE
Therefore, the PER of a company is the same as the ratio (q) of value creation multiplied by the inverse of the ROE of a company. For the PER to increase the same conditions are required that were explained before as far as the ratio of value creation is concerned (q):
- The ROE must grow and be higher than the profit asked for by the shareholders (K).
- The growth (g) must increase.
- The profit asked for by the shareholders (K) must decrease.
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