What question did this study set out to answer?

The aim is to explore the historical development of equity valuation methods and critique the P/E ratio's reliability.

January 20, 20260 citationsOpen Access

An Intellectual History of Equity Valuation: From Discounted Income to Implied Returns // The Origin of the P/E Ratio

Key Points

The aim is to explore the historical development of equity valuation methods and critique the P/E ratio's reliability.
Examined theoretical foundations of equity valuation from historical perspectives
Analyzed the Gordon–Shapiro model and discounted cash flow models
Introduced new valuation metrics like Potential Payback Period (PPP) and SIRRIPA
Identified the P/E ratio as problematic and non-invertible
Demonstrated that DCF models are generalizations rather than distinct theories
Restored clarity and cross-asset comparability in valuation using new metrics

Abstract

This paper examines the intellectual evolution of equity valuation from discounted income theory to return-based frameworks. It revisits the foundations of present value in actuarial science and early twentieth-century economics, and their formalization in the Gordon–Shapiro model, before situating discounted cash flow models (DCFM) as a numerical generalization rather than a distinct valuation theory. The paper argues that the widespread reliance on the price-to-earnings (P/E) ratio is problematic, as the metric is derived, non-invertible, and prone to conflating growth-driven long earnings duration with overvaluation. It then introduces the Potential Payback Period (PPP) and the Stock Internal Rate of Return Including Price Appreciation (SIRRIPA) as a re-expression of discounted-income valuation in time and return space, restoring interpretability and cross-asset comparability to equity valuation.

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