Earning multiples

- Market prices incorporate all kinds of information. For example, the market prices for firms in a given industry include average investor expectations about future earnings growth in that industry and required rates of return for firms in that industry. This information is summarized in the price earnings or P/E ratio, computed as price per share, divided by earnings per share. This P/E ratio is the price multiple exactly analogous to the price per square foot number we used an estimating the value of the house next door to the house in which I grew up. In general, industries in which expected future earnings growth is expected to be high are characterized by high P/E ratios, like houses in Beverly Hills with high prices per square foot. An example is any kind of high technology industries such as software development or pharmaceuticals. Conversely, in industries where expected future earnings growth is low P/E ratios are…