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This computation shows that you would expect a long-run rate of return from investing in Wal-greens stock of 14.4 percent. If your required rate of return was 9.0 percent, you would buy this stock recognizing it is a long-run expectation.

Additional Measures of Relative Value

The best-known measure of relative value for common stock is the price/earnings ratio or the earnings multiplier because it is derived from the dividend growth model and has stood the test of time as a useful measure of relative value. Analysts have also begun to calculate three additional measures of relative value for common stocks—the price/book value ratio, the price/cash flow ratio, and the price/sales ratio, which are demonstrated in this section.

Price/Book Value The price-to-book-value ratio (P/BV) has gained prominence because of the studies by several (P/BV) Ratio authors.18 The rationale is that book value can be a reasonable measure of value for firms that have consistent accounting practice (for example, firms in the same industry). Notably, this measure can apply to firms with negative earnings or negative cash flows. You should not attempt to use this ratio to compare firms with different levels of hard assets—for example, a heavy industrial firm to a service firm.

18Eugene F. Fama and Kenneth R. French, "The Cross Section of Expected Stock Returns," Journal of Finance 47, no. 2 (June 1992): 427-450; Barr Rosenberg, Kenneth Raid, and Ronald Lanstein, "Persuasive Evidence of Market Inefficiency," Journal of Portfolio Management 11, no. 3 (Spring 1985): 9-17; and Patricia Fairfield, "PIE, PIB and the Present Value of Future Dividends," Financial Analysts Journal 50, no. 4 (July-August 19): 23-31.

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