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

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

The analyst should adjust earnings for material differences between IFRS and US GAAP before comparing P/E ratios. Different accounting treatments change reported earnings, so unadjusted multiples are not comparable. Picking the higher ratio or using an industry average does not fix the inconsistency in the underlying earnings.

  1. AUse only the higher of the two P/E ratios
  2. BAdjust earnings for material accounting differences between the two frameworksCorrect
  3. CReplace both P/E ratios with the industry average

Explanation

Differences in accounting standards can change reported earnings and book values, so multiples are not directly comparable. The analyst should adjust for material differences before comparing. Using the higher ratio or substituting an industry average does not address the inconsistency.

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