Explaining the High P/E Ratios: The Message from the Gordon Model

Vol. 16 No.4, 2018
Heinz Zimmermann

Are the high valuation levels of equity prices, after controlling for the low interest rate level, driven by irrational exuberance and excessive growth expectations? The Gordon model helps for a consistent interpretation of commonly used valuation ratios. Overall,
P/E ratios do not seem to be caused by irrational growth expectations, rather a decline can be observed over the past years. Discount rates are the major drivers of high valuation levels in Europe and particularly in Switzerland, while profitability is the major source in
the US and Germany.