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Chapter 10

3.2 Strengths and weaknesses of the P/E valuation method

Strengths Weaknesses

 They are commonly used and  They are based on accounting
are well understood. profits rather than cash flows.

 They are relevant for valuing a  It is difficult to identify a suitable
controlling interest in an entity. P/E ratio, particularly when

valuing the shares of an
unquoted entity.

 It is difficult to establish the
relevant level of sustainable

earnings.

Example 3

Molier is an unquoted entity with a recently reported after-tax earnings of
$3,840,000. It has issued 1 million ordinary shares with nominal value of $0.50
each. A similar listed entity has a P/E ratio of 9.

What is the current value of one ordinary share in Molier using the P/E
basis of valuation?
A $34.56 million

B $69.12 million

C $34.56

D $69.12

Solution

The answer is (C).

EPS = 3,840,000/1,000,000 shares = $3.84

Value per share = P/E × EPS = 9 × $3.84 = $34.56

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