Implied PE

Investalks 2011-09-30 by jackphang

Implied P/E is the value that a company should have based on its 'fundamentals'. You have two calculations for PE based on trailing or leading earnings.

p0/e1=(1-b)/r-g
p0/e0=(1-b)*(1+g)/r-g

p=share price
e=eps
b=retained earnings
r=require rate of return/cost of capital
g=growth rate
1-b can treat as dividend payout ratio

As you can see the higher the growth rate the higher the p/e
But when comparing to the industry if the industry has a higher growth rate than the company that means that the company's p/e needs to be less than that of the index. Basically the index incorporates more growth in its P/E.

If market PE < implied PE, then buy. Else, sell.