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Chapter 10

Earnings based valuation

3.1 The P/E valuation method

Value per share = EPS × P/E ratio

Total value of equity = Total post-tax earnings × P/E ratio

Which earnings figure?

Starting point: The current post-tax earnings, or EPS

BUT this is historic, not expected, future earnings.

Adjust for factors such as:

 one-off items which will not recur in the coming year (e.g. debt write offs in
the previous year)

 directors' salaries which might be adjusted after a takeover has been
completed

 synergies.

Which P/E ratio?

An unquoted company will not have a market-driven P/E ratio, so
an industry average P/E, or one for a similar company, will be used
as a proxy.

However, proxy P/E ratios are also sometimes used when valuing a
quoted company too – if a quoted entity's own P/E ratio is applied to
its own earnings figure, the calculation will just give the existing
share price.

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