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CFA Level I · CFA Level I Exam · Financial Analysis Techniques

An analyst compares two retailers and finds that Retailer X has a higher price-to-earnings (P/E) ratio than Retailer Y. Holding everything else equal, which of the following is the most likely explanation for the higher P/E of Retailer X?

Higher expected earnings growth is the most likely explanation. Investors pay more per unit of current earnings when they expect earnings to grow faster. A higher required return or lower growth would lower the justified P/E, not raise it, so those explanations are inconsistent.

  1. ALower expected earnings growth
  2. BHigher required return by investors
  3. CHigher expected earnings growthCorrect

Explanation

A higher P/E generally reflects higher expected growth in earnings and/or a lower required return (lower risk). Lower growth or a higher required return would tend to reduce the multiple, so those options point in the wrong direction.

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