There are two key questions that we need to address with every multiple. The first relates to the variables that determine that multiple and the second to the relationship between each of the variables and the multiple. In this section, we consider both issues.

8.3.1. Determinants of Equity Multiples

In Chapter 7, we laid the groundwork for analyzing equity multiples by starting with a stable growth dividend discount model and then stating multiples in terms of fundamentals. Table 8.5 reviews our findings.

The models can be stated in terms of either actual dividends (payout ratio) or potential dividends (FCFE/Earnings). All of the equity multiples, other than the PEG ratio, increase as the payout ratio and the growth rate increase, and decrease with the riskiness of the firm. Although these are the only variables that matter for the earnings multiples, the return on equity and the net profit margin are the additional variables that determine price-to-book and price-to-sales ratios, respectively.

Table 8.5. Determinants of Equity Multiples: Stable-Growth Model
Multiple AnalyzedStable-Growth DDM Model
Value of equity
P/E ratio (using current earnings)
P/E ratio (using forward earnings)
PEG ratio
Market-to-book equity
Price-to-sales ratio

The equity ...

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