<p>This paper examines the relation between the forward price-to-earnings (P/E) ratio and profitability. Consistent with the theoretical predictions of Ohlson and Zhan (2006), this paper finds a U-shaped relation between the forward P/E ratio and return on equity (ROE). Besides, firms with high P/E ratios tend to have lower ROE in the subsequent years, and their ROE is very volatile and wide-distributed. Using the GSCORE from Mohanram (2005), this paper separates winners from losers among high P/E firms. Firms with high GSCORE yield higher earnings growth, sale growth, ROE, and excess stock returns in the following years.</p>

This paper investigates the validity and usefulness of “hybrid” valuation models. We recast the model in Ohlson and Johannesson (2016) as a hybrid of the Dividend Discount Model and an earnings-based price multiple model, and develop a new hybrid model that generalizes the Residual Income Valuation Model. After validating the theoretical properties of these models' unique parameters, we assess the usefulness of the hybrid models in two applications. In application one, we find that intrinsic values from the hybrid models are more accurate than those from common discounted models or price multiple models. These improvements are attributable to the hybrid models' ability to incorporate stock price and more realistic assumptions about growth. In application two, we find that the implied cost of equity from the hybrid models better captures systematic risks and key idiosyncratic risks, and captures expected returns. These results demonstrate the validity and usefulness of hybrid valuation models. JEL Classifications: G12; G14; G17; G31; M41. Data Availability: The data used are publicly available from the sources cited in the text.

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