Financial Management · Models for the valuation of shares

Market-Based Valuation: P/E Ratio and Earnings Yield for ACCA FM

Updated 11 October 2026 · Fact-checked

The P/E method values a share by multiplying earnings per share by a suitable P/E ratio. Share value = EPS × P/E. Earnings yield is the inverse: EPS ÷ price. For a company value, use total earnings × P/E. Choose a P/E from a similar quoted company and adjust it for risk.

Understand Market-Based Valuation: P/E Ratio and Earnings Yield

A price/earnings (P/E) ratio tells you how many years of current earnings investors pay for a share. If a share costs $6 and earns $0.50 per share, the P/E is 12. Investors are paying 12 times earnings.

The method works in reverse for valuation. You do not know the value, so you borrow a P/E from a comparable company or from the sector. You multiply it by the earnings per share (EPS) of the company you are valuing. The result is an estimate of the share price. You can also multiply the P/E by total earnings to get the value of the whole equity.

Earnings yield is the same information turned upside down. It is EPS ÷ share price, shown as a percentage. A P/E of 12.5 equals an earnings yield of 8%. To value with it, divide earnings by the yield. This gives the same answer as using the P/E.

A high P/E usually means the market expects strong growth or sees low risk. A low P/E suggests low growth or high risk. That is why you cannot just copy any P/E. For an unquoted company, shares are harder to sell and the business is often riskier. So you normally reduce the quoted P/E, often by 20% to 50%, unless the question gives a figure. Use the discount the question states.

The method is quick, but it has limits. It relies on accounting earnings, which can be changed by accounting policies. It assumes the comparable company is truly similar. It uses a single year's earnings, which may not be typical. And a market P/E can be distorted if markets are over- or under-valuing shares at that time.

Key rules to remember

P/E ratio: P/E = Market price per share ÷ EPS; Use the same earnings basis (usually after tax and after preference dividends) for EPS.
Share value by P/E: Value per share = EPS × P/E ratio; The P/E must come from a comparable company or be given in the question.
Value of equity: Equity value = Total earnings attributable to ordinary shareholders × P/E ratio; Divide by the number of shares for a value per share.
Earnings yield: Earnings yield = EPS ÷ Market price per share = 1 ÷ P/E; Express as a percentage.
Value using earnings yield: Value per share = EPS ÷ Earnings yield; Gives the same answer as EPS × P/E if the yield is 1 ÷ the P/E.
EPS: EPS = (Profit after tax − Preference dividends) ÷ Number of ordinary shares; Use the weighted average number of shares if the number changed in the year.

How to solve Market-Based Valuation: P/E Ratio and Earnings Yield questions

Use this order for any P/E or earnings yield valuation question.

1Find the earnings that belong to ordinary shareholders: profit after tax less preference dividends. Adjust for any one-off items or expected changes if the question tells you to.
2Calculate EPS by dividing those earnings by the number of ordinary shares.
3Identify the P/E ratio or earnings yield to use. It may be given for a similar quoted company or for the sector.
4If the target is unquoted or riskier, adjust the P/E as the question instructs, for example by reducing it by 25%.
5If you are given an earnings yield, convert it: P/E = 1 ÷ yield. Or divide earnings by the yield directly.
6Multiply EPS by the P/E to get the value per share. Multiply total earnings by the P/E to get the equity value.
7Compare with any current or offer price, and comment on reliability if the question asks for it.

Quickest way: Total earnings ÷ yield shortcut

When to use it: Use when the question gives an earnings yield or asks for the value of the whole company and does not need EPS.

Take total earnings for ordinary shareholders.
If given a P/E, multiply by it. If given a yield, divide by it.
Divide by the number of shares only if the question asks for a value per share.
Check the answer is sensible: a P/E of about 10 should give a value of about 10 times earnings.

Common mistakes in Market-Based Valuation: P/E Ratio and Earnings Yield

Using profit before tax or before preference dividends to calculate EPS.
Students take the first profit figure they see.
Fix: Always use profit after tax less preference dividends, then divide by ordinary shares.
Multiplying earnings by the earnings yield instead of dividing.
Yield and P/E are confused because they are inverses.
Fix: Remember: P/E multiplies, yield divides. A yield of 8% means a P/E of 12.5.
Using a quoted company's P/E for an unquoted company without adjustment.
The adjustment for lack of marketability is overlooked.
Fix: Check whether the question states a discount. If it does, apply it to the P/E before valuing.
Mixing the value of the whole company with the value per share.
Total earnings and EPS are used in the same calculation.
Fix: Keep the pair consistent: total earnings × P/E gives total value. EPS × P/E gives value per share.
Writing about reliability without being specific.
Students give a generic answer such as 'it is not always accurate'.
Fix: Name the issue: earnings manipulation, a non-comparable company, a single year's earnings or an unusual market price.

Worked examples

Example 1

Zeta Co, an unquoted company, has profit after tax of $900,000 and 1,500,000 ordinary shares. A similar quoted company has a P/E ratio of 14. Zeta's directors believe a 30% discount to this P/E is appropriate. Value Zeta's shares.

Show the solution

EPS = $900,000 ÷ 1,500,000 = $0.60.
Adjusted P/E = 14 × (1 − 0.30) = 9.8.
Value per share = $0.60 × 9.8 = $5.88.
Equity value check: $900,000 × 9.8 = $8,820,000. Dividing by 1,500,000 shares gives $5.88.

Answer: The estimated value is $5.88 per share, or $8,820,000 for the whole equity.

Example 2

Kora Co has profit after tax of $2,400,000 and pays preference dividends of $400,000. It has 8,000,000 ordinary shares. The sector earnings yield is 10%. Estimate the value per share and state Kora's implied P/E.

Show the solution

Earnings for ordinary shareholders = $2,400,000 − $400,000 = $2,000,000.
EPS = $2,000,000 ÷ 8,000,000 = $0.25.
Implied P/E = 1 ÷ 0.10 = 10.
Value per share = $0.25 ÷ 0.10 = $2.50.
Check: $0.25 × 10 = $2.50.

Answer: The value is $2.50 per share (equity value $20,000,000), using a P/E of 10.

Exam tips

In Section A, read whether the question asks for value per share or total value before you start.
Always show EPS as a separate line in Section C. Marks are given for method even if the P/E is wrong.
Write the P/E adjustment explicitly, for example '14 × 0.7', so the marker can see it.
If asked to comment, give at least two specific limitations and link them to the company in the scenario.
In objective questions, an answer that uses the inverse of the correct ratio is often one of the wrong options. Check whether you multiply or divide.

Practice questions from Models for the valuation of shares

Market-Based Valuation: P/E Ratio and Earnings Yield in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Market-Based Valuation: P/E Ratio and Earnings Yield: frequently asked questions

What is the difference between P/E ratio and earnings yield?

They carry the same information in opposite forms. P/E is price ÷ EPS. Earnings yield is EPS ÷ price, shown as a percentage. A P/E of 20 is an earnings yield of 5%.

How do I value an unquoted company using the P/E method?

Calculate its EPS or total earnings. Take the P/E of a similar quoted company and reduce it for lower marketability and higher risk, using the discount the question gives. Multiply the adjusted P/E by earnings.

When is the P/E method unreliable?

It is unreliable when earnings are unusual or can be manipulated, when the comparable company is not truly similar, or when the market is mispricing shares. It also relies on one year's earnings.

Does a high P/E mean a share is overvalued?

Not necessarily. A high P/E can reflect high expected growth or low risk. You must compare it with similar companies and consider the reasons for the difference.