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CFA Level I · CFA Level I Exam · Relative Value Equity Valuation Approaches

An analyst compares the P/E of a Japanese manufacturer reporting under IFRS with that of a US peer reporting under US GAAP. Which of the following is the most appropriate step before drawing conclusions from the comparison?

The most appropriate step is to adjust earnings for differences in accounting standards. IFRS and US GAAP can produce different reported earnings, which distorts P/E comparisons. Currency conversion is unnecessary for a ratio, since price and earnings are already in the same currency within each company.

  1. AAdjust earnings for accounting differencesCorrect
  2. BUse the higher of the two P/E ratios
  3. CConvert both P/Es into a common currency

Explanation

P/E is a ratio of price to earnings per share, so differences in accounting standards can change the earnings figure and distort comparability. Adjusting earnings for those differences makes the ratios comparable. Currency conversion is unnecessary because a ratio is free of currency units when price and earnings share a currency.

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