The Valuation Accuracy of the Price-Earnings and Price-Book Benchmark Valuation Methods
Posted: 25 Jul 2003
This paper evaluates the valaution accuracy of the price-earnings (P/E), the price-book (P/B) and a combined price-earnings and price-book (P/E-P/B) benchmark valuation methods. Performance of the benchmark valuation methods relies on the definition of comparable firms. In this paper, comparable firms are selected based on industry membership, size and return on equity as well as combinations of industry membership with size and with return on equity. We find that within the P/E and P/B benchmark valuation methods, the best definition of the comparable firms is based on industry membership combined with reutrn on equity. However, only the industry membership is necessary to define the comparable firms for the combined P/E-P/B method. In sum, the results suggest that, when firm's value is unknown, the best valuation approach is to select comparable firms based on industry membership and use the combined P/E-P/B valuation approach. We also find that the P/E benchmark valuation method performs better than the P/B benchmark valuation method and the combined method outperforms either the P/E or the P/B method. These results imply that earnings are more important than book value as a single-number firm valuator and that both earnings and book values are value relevant, one does not substitute perfectly for the other.
JEL Classification: G12
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