Re: Relationship between P/E and inverse of P/E (2 questions)
1a) Inverse of PE is indeed Earnings Yield. It is NOT cost of equity because cost of equity is typically derived from CAPM whereas PE and Earnings Yield can be thought of as a "market-driven" or "market-demanded" cost of equity. Therefore it WOULD be appropriate to say that Earnings Yield is essenti... 1a) Inverse of PE is indeed Earnings Yield. It is NOT cost of equity because cost of equity is typically derived from CAPM whereas PE and Earnings Yield can be thought of as a "market-driven" or "market-demanded" cost of equity. Therefore it WOULD be appropriate to say that Earnings Yield is essentially the cost of equity that equity investors are demanding, but again, not the traditional CAPM cost of equity. As to which is more relevant or important - well it depends on context. For purposes of WACC, we are "supposed" to use CAPM, or rather, the convention is to use CAPM, but using Earnings Yield as an additional data point doesn't hurt.

1b) The perpetuity growth stuff you posted from KPMG we are honestly going to ignore. Don't use anything that is academic and theoretical.

2) If investors require a particular return, i.e. via CAPM (required return), then in essence that is the company's cost of equity. If your brother wants you to invest $100 in his new shoe business and you want a 10% return (that's required return) then in essence your brother has to get you a 10% return somehow otherwise you wouldn't invest - therefore, that is your brother's cost of acquiring equity capital, or your $100.

ROE is a separate concept - Net Income divided by Book Value. Since no one dividends out all their Net Income (that would be a 100% dividend payout rate, only REITs come close at 90% but different concept), you don't actually receive the entire Net Income. Therefore ROE is a metric to compare and see how much money (Net Income) was generated for the ENTIRE equity base (Book Value), and not necessarily to calculate valuation. Usually of course there is a positive correlation between high ROE and high PE stocks. ROE specifically does NOT use market value of equity. If it did, then it would be Earnings Yield which is Net Income divided by Equity Value (market value of equity). Remember that if you take Equity Value / Net Income and divide both numerator and denominator by Shares Outstanding, you get PE. Read More

Relationship between P/E and inverse of P/E (2 questions)
Hi! First, awesome videos! Follow up questions on multiples, esp for listed companies valuation when analysing a stock in a long short fund context: 1. Is inverse of P/E = earnings yield = cost of equity? I was looking through this link and it states that this statement is wrong ie inverse o... Hi!

First, awesome videos!

Follow up questions on multiples, esp for listed companies valuation when analysing a stock in a long short fund context:
1. Is inverse of P/E = earnings yield = cost of equity? I was looking through this link and it states that this statement is wrong ie inverse of P/E does not estimate the cost of equity to equity investors. Wanted to get your opinion if all these below in the link are practical application to real life valuation or these are just theories that are not applicable?

Please see link: https://home.kpmg.com/jm/en/home/insights/2016/06/cost-of-equity--return-on-equity--p-e---what-do-these-mean-.html

The article incorporates perpetuity growth method so
inverse of P/E = Capitalisation multiple = 1/(Ke – g)
Market value = Maintainable earnings x (1 + g) x 1/(Ke - g)
Capitalisation multiple = (1+g)/(Ke – g)
cost of equity = Kei ? [(1+g)/(P/E)] + g

2. Can you shed light on the relationship between cost of equity, required return to equity investors (uses market value so more useful to equity investors), ROE (more of using book value so less useful to an equity investor?). I am a little confused when using these when evaluating multiple and doing different valuation methods. There are a few literature that have differing views on the use in public market valuation. Read More

Re: DCF - can you project with a change in capital structure
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Re: measuring capital charge
We love Damodaran, but sometimes his approach is still academic and not real world. In cases of firms with a "rent vs. buy" decision that is related to COGS, mostly transport companies, such as airlines or rental cars, indeed we look at EBITDAR instead of EBITDA and our "Adjusted Enterprise Value... We love Damodaran, but sometimes his approach is still academic and not real world.

In cases of firms with a "rent vs. buy" decision that is related to COGS, mostly transport companies, such as airlines or rental cars, indeed we look at EBITDAR instead of EBITDA and our "Adjusted Enterprise Value" must include both the operating and capital leases in the capital structure.

This is covered in our Private Company Valuation - Valuation Nuances course where we go over this very topic and how to proper account for it in the context of valuation. Read More

measuring capital charge
Hi from the course, I see that you are using total capital to calculate capital charge. I was reading up on Damodaran's explanation on this as well and don't understand that, can you elaborate? "In cases where firms alter their capital invested through their operating decisions (for example, by usin... Hi from the course, I see that you are using total capital to calculate capital charge. I was reading up on Damodaran's explanation on this as well and don't understand that, can you elaborate? "In cases where firms alter their capital invested through their operating decisions (for example, by using operating leases), the capital and the after-tax operating income have to be adjusted to reflect true capital invested." Does that mean the EBIT and total capital has to be scrubbed/adjusted before using it for EVA? How do you do that and is that necessary when you model out listed companies?

Link: http://people.stern.nyu.edu/adamodar/New_Home_Page/lectures/eva.html

His comments:
Many firms use the book value of capital invested as their measure of capital invested. To the degree that book value reflects accounting choices made over time, this may not be true. In cases where firms alter their capital invested through their operating decisions (for example, by using operating leases), the capital and the after-tax operating income have to be adjusted to reflect true capital invested. Read More