The Levered P/E Ratio

Posted: 14 Sep 2003

See all articles by Martin L. Leibowitz

Martin L. Leibowitz

Teachers Insurance and Annuity Association College Retirement Equities Fund (TIAA-CREF)

Abstract

A vast literature examines the role of debt in corporate valuation, but most of these works proceed from the vantage point of corporate finance (i.e., ascertaining the effects of adding debt to a previously unlevered company). The investment analyst, however, confronts an already-levered company with already-levered return parameters. The analyst's challenge is to estimate the stock's theoretical value by inferring the company's underlying structure of returns. This shift in vantage point leads to results about the effect of leverage that are surprisingly different from the results of studies from the corporate finance angle. Whereas corporate finance studies found only a moderate effect of leverage, when viewed from the analyst's perspective, a company's value has such a high degree of sensitivity to the leverage ratio that it can significantly alter the theoretical P/E valuation. Moreover, from the analyst's vantage point, leverage always moves the P/E toward a lower value than that obtained from the standard formula.

Keywords: Equity Investments: fundamental analysis and valuation models, Corporate Finance

Suggested Citation

Leibowitz, Martin L., The Levered P/E Ratio. Available at SSRN: https://ssrn.com/abstract=377483

Martin L. Leibowitz (Contact Author)

Teachers Insurance and Annuity Association College Retirement Equities Fund (TIAA-CREF) ( email )

730 Third Avenue
New York, NY 10017-3206
United States

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