If investors distinguish between companies’ accounting methods in capitalizing earnings, then one would expect more conservative (i.e., income-decreasing) methods to be associated with higher price-earnings ratios. Using a sample of 117 firms over the 1970–75 period, the authors examined the relation between a company’s P/E ratio and its method of accounting for inventory (LIFO versus FIFO), depreciation (accelerated or straight-line) and investment tax credit (deferred or flow-through); financial variables controlled for dividends, growth, beta and firm size.
The results indicate that dividend payout and firm size were the most important financial variables. Of the accounting variables, inventory method and investment tax credit method were significantly related to P/E ratio; companies that chose LIFO inventory and deferred investment tax credit had higher price-earnings ratios than companies that chose FIFO and flow-through tax credit. Depreciation method did not appear to be related to P/E.
