We have seen that the P/E ratio is a commonly used price multiple for valuing a company.

However, an analyst needs to analyze the P/E ratio in the larger context of the other financials of the company and need to be able to determine whether its P/E ratio is supported by the other factors.

In terms of fundamental valuation, the P/E ratio can be written as:

Note here that D1/E is the dividend payout ratio, k is the required rate of return, and g is the growth rate.

Looking at this formula, we can say that:

**Dividend payout ratio:**If a company has a higher dividend payout ratio than the industry average, it supports a higher P/E ratio for the company.**Growth rate:**If a company has a higher growth rate than the industry average, it supports a higher P/E ratio for the company.**Required rate of return:**A lower required rate of return supports a higher P/E ratio for the company.

We can also infer that if a company has high debt, it indicates a higher required return on equity, which in turn means support for lower P/E ratio.

Using a simple analysis like this, an analyst can see what kind of support is there for P/E ratio.

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