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CFA Level I Exam · Relative Value Equity Valuation Approaches

Dividend Yield, PEG Ratio and Justified Multiples

Updated 7 October 2026 · Fact-checked

Dividend yield is dividends per share divided by price. The PEG ratio is the P/E divided by the expected earnings growth rate in percent. Justified multiples come from fundamentals such as growth, payout and required return. To solve questions, compute the multiple, compare it with a benchmark or its justified value, then judge value.

Understand Dividend Yield and Other Multiples Concepts

A valuation multiple is a price (or value) divided by a fundamental such as earnings, book value or dividends. Multiples let you compare companies of different size on one scale.

Dividend yield = dividends per share ÷ price per share. It is the income part of an equity return. A high yield can mean a cheap stock, but it can also signal that the market expects dividends to be cut. The yield alone says nothing about growth.

The PEG ratio = P/E ÷ expected earnings growth rate (growth entered as a whole number, such as 12 for 12%). It adjusts the P/E for growth. A lower PEG suggests the stock is cheaper per unit of growth. It is only a rough guide. It ignores risk, and it assumes P/E rises in proportion to growth. Compare PEGs only among firms with similar risk and similar growth patterns, and use the same growth definition for all.

Multiples can be trailing (based on past earnings) or forward (based on forecasts). A justified multiple is the value the fundamentals imply, for example from the Gordon growth model. An unjustified or actual multiple is what the market currently pays. If the actual multiple is above the justified one, the stock looks overvalued. If below, it looks undervalued.

Fundamentals drive multiples. Higher growth raises P/E. Higher required return lowers it. A higher payout ratio raises the justified P/E only when growth is held constant. In practice a higher payout usually means less reinvestment and lower growth, so the effect is not always positive.

Key formulas to remember

Dividend yield
Dividend yield = D ÷ P
Use the same dividend basis (trailing or forward) for every stock you compare.
PEG ratio
PEG = (P/E) ÷ (expected EPS growth rate in %)
Growth is a whole number: 15% growth means divide by 15. Lower PEG means cheaper relative to growth.
Justified forward P/E (Gordon growth)
P0/E1 = payout ratio ÷ (r − g)
Uses next year's earnings E1 and payout = D1 ÷ E1. Requires r > g.
Justified trailing P/E (Gordon growth)
P0/E0 = payout × (1 + g) ÷ (r − g)
Equals the forward P/E times (1 + g).
Dividend growth link
g = retention rate × ROE = (1 − payout) × ROE
The sustainable growth rate, used to link payout to growth.
Justified price from multiple
Value = justified multiple × fundamental
For example justified P/E × forecast EPS.

How to solve Dividend Yield and Other Multiples Concepts questions

Use this order for most questions on dividend yield, PEG and justified multiples.

  1. 1Identify the multiple asked for and whether it is trailing or forward.
  2. 2List the inputs given: price, dividend, EPS, growth, payout, required return r, ROE.
  3. 3If growth is not given, compute it as (1 − payout) × ROE.
  4. 4Compute the multiple with the correct formula. Enter PEG growth as a whole number.
  5. 5For a justified multiple, check that r > g and that you use E1 for the forward P/E or E0 × (1 + g) logic for the trailing P/E.
  6. 6Compare the actual multiple with the justified one or with the peer benchmark.
  7. 7Decide: actual above justified suggests overvalued; below suggests undervalued.
  8. 8Eliminate options that reverse the direction or use the wrong growth units.

Quickest way: Direction check, then one calculation

When to use it: When time is short and options are numerical or directional.

  1. Predict the direction first: higher g or lower r raises P/E; higher r lowers it.
  2. Compute only the one multiple needed. Keep payout as a decimal.
  3. Check that PEG growth is not used as a decimal. A PEG of 0.15 instead of 1.5 is a unit error.
  4. Discard options that break the direction check, then match the remaining answer.

Common mistakes in Dividend Yield and Other Multiples Concepts

  • Entering growth as a decimal in the PEG ratio

    You are used to using 0.12 in formulas.

    Fix: For PEG, use 12 for 12%. Divide P/E by 12.

  • Using the justified forward P/E formula for a trailing P/E

    Both formulas look alike.

    Fix: Forward P/E = payout ÷ (r − g). Trailing P/E multiplies the numerator by (1 + g).

  • Assuming a higher payout always raises P/E

    Payout is in the numerator.

    Fix: Payout raises P/E only with growth fixed. If more payout means less retention, g falls and P/E may fall.

  • Treating a high dividend yield as proof of undervaluation

    Cheap-looking income feels attractive.

    Fix: A high yield may reflect expected dividend cuts or low growth. Check fundamentals.

  • Comparing PEG ratios across firms with different risk

    PEG looks like a risk-free adjustment.

    Fix: PEG ignores risk. Compare only similar-risk firms with the same growth definition.

  • Reversing the conclusion when comparing actual and justified multiples

    Rushing under time pressure.

    Fix: Actual above justified means overvalued. Write it beside the question before choosing.

Worked examples

Example 1

A company has a share price of $60, expected EPS growth of 12% a year and forward EPS of $3.00. A peer has a PEG of 1.9. Is the company cheaper than the peer on PEG? Options: A. Yes, its PEG is 1.67; B. No, its PEG is 2.4; C. Yes, its PEG is 16.7

Show the solution
  1. P/E = 60 ÷ 3.00 = 20.0.
  2. PEG = 20.0 ÷ 12 = 1.667, which rounds to 1.67.
  3. Peer PEG is 1.9, higher than 1.67.
  4. A lower PEG means cheaper per unit of growth, so the company is cheaper on this measure. Option B uses a wrong PEG of 2.4 (P/E × 0.12), which would imply the company is more expensive than the peer. Option C comes from a unit slip (dividing by 1.2 instead of 12, so 20 ÷ 1.2 = 16.7).

Answer: A. Yes, its PEG is 1.67. The company looks cheaper than the peer, ignoring risk differences.

Example 2

A stock has a payout ratio of 40%, required return of 10% and constant dividend growth of 5%. Next year's EPS is forecast at $2.50 and the stock trades at $12. What is the justified forward P/E, and does the stock look over- or undervalued? Options: A. 4.0, overvalued; B. 8.0, undervalued; C. 20.0, undervalued

Show the solution
  1. Justified forward P/E = 0.40 ÷ (0.10 − 0.05) = 0.40 ÷ 0.05 = 8.0.
  2. Justified price = 8.0 × 2.50 = $20.00.
  3. Actual forward P/E = 12 ÷ 2.50 = 4.8.
  4. Actual P/E 4.8 is below justified 8.0, and market price $12 is below $20, so the stock looks undervalued.
  5. Option A comes from dividing the payout by r only (0.40 ÷ 0.10 = 4.0), which ignores growth. Option C comes from leaving out the payout ratio (1 ÷ 0.05 = 20.0).

Answer: B. Justified forward P/E is 8.0, implying a value of $20.00. The stock trades at $12, so it looks undervalued.

Exam tips

  • Read whether the question wants a trailing or forward multiple before you touch the formula.
  • Convert growth to a whole number for PEG and a decimal for Gordon growth. State the unit in your mind each time.
  • Questions often ask how a multiple changes when r, g or payout changes. Use the formula direction, not a full calculation.
  • With three options and no penalty, always answer. Remove any option with the wrong over/undervalued direction first.
  • If a question asks for growth and gives ROE and payout, use g = (1 − payout) × ROE.

Practice questions from Relative Value Equity Valuation Approaches

Dividend Yield and Other Multiples Concepts in other exams

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

Dividend Yield and Other Multiples Concepts: frequently asked questions

How do I calculate the PEG ratio?

Divide the P/E by the expected earnings growth rate expressed as a whole number. For example, a P/E of 18 and growth of 9% gives a PEG of 2.0. A lower PEG suggests a cheaper stock relative to growth.

What is the difference between justified and unjustified multiples?

A justified multiple is the value implied by fundamentals such as growth, payout and required return. An unjustified multiple is the one the market actually shows. Comparing the two tells you whether the stock looks over- or undervalued.

Does a higher dividend payout ratio raise the P/E?

In the Gordon growth formula, higher payout raises P/E if growth and required return stay the same. In practice, paying out more usually lowers retention and growth, so the net effect depends on the case.

Is a high dividend yield a sign of a cheap stock?

Not always. A high yield can come from a low price because the market expects weak growth or a dividend cut. Use it as one signal alongside growth and risk.