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Structural properties of the price-to-earnings and price-to-book ratios

Nezlobin, Alexander, Rajan, Madhav V. and Reichelstein, Stefan (2016) Structural properties of the price-to-earnings and price-to-book ratios. Review of Accounting Studies, 21 (2). 438 - 472. ISSN 1380-6653

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Identification Number: 10.1007/s11142-016-9356-0

Abstract

We examine the structural properties of a firm’s price-to-earnings (P/E) and price-to-book (P/B) ratios and the relation between these two ratios. A benchmark result is obtained under the hypothesis that firms use replacement cost accounting to value their operating assets, so that the P/B ratio coincides with Tobin’s q. The firm’s P/E ratio can then be expressed as a convex combination of the P/E ratios suggested respectively by the permanent earnings model and the Gordon growth model, with the relative weight to be placed on these two endpoints determined entirely by Tobin’s q. Under current financial reporting rules, the accounting for operating assets is likely to be more conservative than replacement cost accounting. Our findings characterize how the magnitude and behavior of the P/E and P/B ratios are jointly shaped by several key variables, including both past and anticipated future growth, economic profitability, and accounting conservatism

Item Type: Article
Official URL: https://link.springer.com/journal/11142
Additional Information: © 2016 Springer Science+Business Media New York
Divisions: Accounting
Subjects: H Social Sciences > HF Commerce > HF5601 Accounting
H Social Sciences > HG Finance
JEL classification: M - Business Administration and Business Economics; Marketing; Accounting > M4 - Accounting and Auditing > M41 - Accounting
L - Industrial Organization > L2 - Firm Objectives, Organization, and Behavior > L25 - Firm Performance: Size, Diversification and Scope, Age, Profit, and Sales
G - Financial Economics > G1 - General Financial Markets > G11 - Portfolio Choice; Investment Decisions
Date Deposited: 04 Nov 2019 11:39
Last Modified: 20 Jan 2020 07:07
URI: http://eprints.lse.ac.uk/id/eprint/102351

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