Financial Management · Nature and purpose of the valuation of business and financial assets

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

Updated 11 October 2026 · Fact-checked

The P/E method values equity as earnings × a suitable P/E ratio, usually taken from a similar listed company. Earnings yield is the reverse: value = earnings ÷ earnings yield. You then adjust the P/E for risk, size, marketability and growth before multiplying. The result is the total equity value; divide by shares for a price per share.

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

The price/earnings (P/E) ratio tells you how many years of current earnings investors pay for a share. A P/E of 10 means the market price is ten times earnings per share (EPS). If you know a comparable company's P/E, you can apply it to your target's earnings to estimate what its equity is worth.

The logic is simple. Similar businesses should be priced similarly per unit of earnings. A high P/E suggests the market expects growth or sees low risk. A low P/E suggests slow growth or high risk.

The earnings yield is the inverse of the P/E. It is earnings ÷ market value, shown as a percentage. A P/E of 8 equals an earnings yield of 12.5% (1 ÷ 8). Both methods give the same answer if you use them consistently. Use the one the question gives you.

The hard part is choosing the P/E. A listed company's P/E reflects a liquid, well-known, diversified business. An unlisted target is usually riskier, smaller and harder to sell. So you normally reduce the P/E, often by 20% to 50%, or by an amount the question states. A target with better growth prospects than the comparator might justify a higher P/E. Always say why you adjust.

The method has limits. It relies on accounting earnings, which depend on accounting policies and can be volatile or manipulated. It uses past or current earnings, not future cash flows. Finding a truly comparable company is hard. Market P/Es also swing with sentiment, so a boom or crash changes the value without any change in the business. It also ignores the capital structure and cash flow timing.

Key rules to remember

P/E ratio: P/E = Market price per share ÷ EPS = Market capitalisation ÷ Total earnings; Use earnings after tax and after preference dividends, available to ordinary shareholders.
Equity value using P/E: Equity value = Total earnings × P/E = EPS × P/E × number of shares; EPS × P/E gives the value per share.
Earnings yield: Earnings yield = EPS ÷ Share price × 100% = 1 ÷ P/E × 100%; The inverse of the P/E.
Equity value using earnings yield: Equity value = Total earnings ÷ Earnings yield; Express the yield as a decimal, e.g. 12.5% = 0.125.
Adjusted P/E: Adjusted P/E = Comparator P/E × (1 − discount); Apply discounts for lower marketability, smaller size or higher risk. Increase it for superior growth.

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

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

1Identify the earnings to use. Take profit after tax, less preference dividends. Check whether the question wants the latest or an average figure.
2Choose the comparator P/E, or the earnings yield, from the data. If several companies are given, use an average or the most similar one and say why.
3Adjust it for differences: unlisted status, smaller size, higher risk, or better growth. Use the percentage the question gives. If none is given, state a sensible one and justify it.
4Convert if needed. If you have an earnings yield, divide earnings by it. This is the same as using P/E = 1 ÷ yield.
5Multiply earnings by the adjusted P/E to get total equity value. For a price per share, use EPS × P/E.
6Adjust the total for any stake. If valuing a part, take the proportion. If the question asks for enterprise value, add net debt only where relevant.
7Comment briefly on limitations if the question asks for it: earnings quality, comparability, volatility of market P/Es.

Quickest way: Earnings × adjusted P/E in three lines

When to use it: Use this for Section A and OT case questions where you only need the final value.

Write earnings (or EPS) and the given P/E.
Apply the stated adjustment to the P/E first, e.g. 12 × 0.75 = 9.
Multiply: earnings × 9. If a yield is given, divide earnings by the yield instead.
Check the units: total value or per share, and the currency.

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

Applying the comparator's P/E without adjusting for an unlisted target.
Students rush to multiply and forget the target is less marketable and often riskier.
Fix: Always read the scenario for listing status, size and risk. Reduce the P/E when the target is unlisted or smaller, and state the adjustment.
Using profit before tax or before preference dividends as earnings.
The wrong line is picked from the income statement.
Fix: Use profit attributable to ordinary shareholders: after interest, tax and preference dividends.
Multiplying by the earnings yield instead of dividing.
Students confuse the yield with the P/E, which are inverses.
Fix: Remember value = earnings ÷ yield. Or convert to P/E (1 ÷ yield) first and multiply.
Mixing per-share and total figures.
EPS and total earnings both appear in the question.
Fix: Pair total earnings with total value and EPS with price per share. Check the answer is sensible against the number of shares.
Applying a discount as a subtraction from the P/E in percentage points.
A '25% reduction' is read as 'P/E minus 25'.
Fix: A 25% reduction means multiply by 0.75. A P/E of 12 becomes 9, not minus 13.
Giving a vague or one-sided discussion of limitations.
Students write only 'P/E is simple' with no reasons.
Fix: Give specific points: accounting policy differences, one-year earnings, hard to find comparables, market sentiment, and no cash flow or timing information.

Worked examples

Example 1

Zenith Ltd is an unlisted company with profit after tax of ₹48,00,000 and 20,00,000 ordinary shares. A similar listed company has a P/E of 14. Because Zenith is unlisted and smaller, its P/E should be 30% lower. Estimate the equity value and the value per share.

Show the solution

Earnings = ₹48,00,000.
Adjusted P/E = 14 × (1 − 0.30) = 14 × 0.70 = 9.8.
Equity value = ₹48,00,000 × 9.8 = ₹4,70,40,000.
EPS = ₹48,00,000 ÷ 20,00,000 = ₹2.40.
Value per share = ₹2.40 × 9.8 = ₹23.52. Check: ₹4,70,40,000 ÷ 20,00,000 = ₹23.52.

Answer: Equity value ₹4,70,40,000; value per share ₹23.52.

Example 2

Orion Ltd has earnings of $3,600,000. Listed companies in the same sector have an average earnings yield of 12.5%. Orion is unlisted and riskier, so its P/E should be reduced by 20% from the sector P/E. Estimate Orion's equity value.

Show the solution

Sector P/E = 1 ÷ 0.125 = 8.
Adjusted P/E = 8 × (1 − 0.20) = 8 × 0.80 = 6.4.
Equity value = $3,600,000 × 6.4 = $23,040,000.
Check by yield: the equivalent yield is 1 ÷ 6.4 = 15.625%. $3,600,000 ÷ 0.15625 = $23,040,000.

Answer: Equity value is $23,040,000.

Exam tips

Read for hints on adjustment: words like unlisted, smaller, higher gearing or faster growth tell you which way to move the P/E.
In OT questions, work the adjustment before multiplying. Options are often built from the unadjusted answer, and the answer is all or nothing.
In Section C, set out earnings, P/E, adjustment and value on separate lines so you earn method marks even if a figure is wrong.
When asked to discuss limitations, give three or four distinct points and tie each to the scenario rather than listing generic ones.
Compare the P/E value with other methods, such as asset-based or dividend valuation, if asked. A range of values is a good answer.

Practice questions from Nature and purpose of the valuation of business and financial assets

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

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

They are inverses. P/E is price ÷ EPS, and earnings yield is EPS ÷ price. A P/E of 10 equals an earnings yield of 10%, and a P/E of 8 equals 12.5%.

How do I value a company using the P/E ratio in ACCA FM?

Take earnings attributable to ordinary shareholders. Choose a comparable company's P/E and adjust it for risk, size and marketability. Multiply earnings by the adjusted P/E to get equity value.

Why is the P/E usually reduced for an unlisted company?

Its shares are harder to sell and its information is less available. It is often smaller and riskier too. Investors pay less per unit of earnings, so the P/E is lower.

What are the limitations of the P/E method?

It depends on accounting earnings, which can be distorted by policies or one-off items. It is hard to find a true comparator, and market P/Es move with sentiment. It also ignores future cash flows and their timing.