Expected earnings growth which affects future ROE. The future earnings of a company are expected to be due to its future growth potential which may be predicted by numerous indicators including forecasted sales growth rate due to market share gains etc.
Such as metrics such as ROA which according to Duponts analysis is composed of Asset turnover multiplied by profit margin. These are a measure of how efficiently the co is able to utilise its assets to convert to sales and then how much of those sales translate to profit. A high ROA is a good indication of a company’s record of being able to convert Investments into profits.
If the market views that the co has made good strategic business decisions in terms of targeting specific consumer segments, geographical positioning, number of stores, marketing, pricing and strategic financial decisions such as appropriate debt/equity mix then this will also influence upon P/E and P/B ratio.
These ratios should be expected to inversely vary with risk, i.e. the higher the risk perception of investors the lower the price which they will be willing to pay for their investment. Risk perception is related to perceived inability of achieving co. strategy, earnings growth etc.
Profitability, Industry Life Cycle and Sector
Factors such as ROE tend to be positively correlated with these ratios so do frequency of positive abnormal or unexpected earnings announcements. The stage of the business life cycle which a company is in also influences these metrics with mature industries tending to have lower ratios. It’s all related to growth prospects certain growing industries such as tech companies tend to have higher multiples than compared to older established industries. Economy wide factors are also a factor with weak economic conditions dragging down multiples due to lower across the board growth prospects.
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