Work out a justified price multiple and explain what it means
The idea
A justified multiple is the multiple a share should trade on given its fundamentals, found by dividing a discounted cash flow value by the relevant per-share measure. From the constant-growth model, justified leading P/E equals payout ratio ÷ (r − g), and trailing P/E equals payout × (1 + g) ÷ (r − g). Comparing the justified multiple with the actual one gives a view: an actual P/E below the justified P/E suggests undervaluation. The analyst can also ask what growth or required return the actual multiple implies. The trap is building the justified multiple on inputs, such as a growth rate, that the company cannot sustain, which simply moves the error from the value into the multiple.
In the app: 1 practice questions on this outcome, a narrated walkthrough with diagrams, spaced review that brings it back before you forget it.
Take the free diagnostic →More in Market-Based Valuation: Price and Enterprise Value Multiples
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