The P/E ratio can be seen to be effected by the following major factors :

**i) Effect due to perceived growth opportunities -PVGO**:

The P/E can be also depicted by the equation

P/E = 1/k[1 + (PVGO / (E/k))].

When future growth opportunities dominate the estimate of the total share price , the share price will be higher relative to the current earnings. **Thus, a firm having an expectation of high growth opportunities will show a high P/E.**

**ii) Effect due to high ROE :**

P/E equation can also be written as :

P/E = [(1-b)]/[(k – ROE x b)]

Where b is the reinvestment rate.

The equation shows that the increasing ROE decreases the denominator and thus increases the P/E ratio. **Thus firms having a higher ROE will have a higher P/E ratio.** However, it is assumed that the reinvestment of earnings into the business gives higher returns than the investor required returns k.

**iii) Effect due to riskier business :**

P/E equation as given above can be written as :

P/E = [(1-b)]/[(k – g)]

Where g=ROE x b , the dividend growth rate. When the business of the firm is riskier as compared to another firm , the investor expected return demanded is more i.e k is higher. **This reduces the denominator and thus results in lower P/E.**

**iv) Effect due to changes in stating earnings :**

The earnings part in the P/E equation can be influenced by the way depreciation is calculated, inventory valuation is done etc. Also , how revenue is recognized can impact the earnings. These treatments effect the P/E ratio .

**v) Effect due to the β of the stock :**

The macro economic factors tend to impact the firms and their earnings differently. Thus the firms having higher β will show higher earnings on a positive business cycle trend as compared to a lower β value stock and a much lower earnings when the business cycle is unfavorable. Thus the P/E ratio will fluctuate much higher as the earnings part is much influenced due to higher β