Abstract
An asset multiple, the ratio of the price of an asset to its invested value, divided by a measure of return on asset is called a price to earning (PE) ratio. The PE ratio can be used in a number of ways to calculate the real expected return on equities, cost of capital, and residual income. This ratio derives from a fundamental equivalence between asset multiple and relative return, which is, empirically as well as theoretically, the backbone of mean reversion in equity markets. But, for the PE ratio to produce this multitude of applications, investors cannot use just any asset multiple or any return. The chapter provides the relationship between price-to-book and return on equity, thereby producing an accounting PE ratio, for a global universe of stocks. In an example given in the chapter, the R-squared of the regression analysis between the two variables is 0.38. This is equivalent to saying that these two variables are dependent on one another at a lower level than the flick of a coin. This does not mean that the price-to-book and return on equity are randomly associated; there is, clearly, an upward-sloping relationship between these two variables.
Published Version
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