DEFINITION of 'Franchise P/E'
The expected value of new business opportunities available to a business. The franchise approach to evaluating a company breaks down the company's observed P/E into two primary components: the P/E coming from the company's business activities (base P/E) and the franchise P/E. In this sense, the franchise P/E = observed P/E - base P/E. It is a function of the rate of return on a business opportunity (the franchise factor) relative to the size of the opportunity (the growth factor).
Franchise Factor (FF) x Growth Factor (G) = (1/k - 1/ROE) x g/(k-g), where:
k = cost of equity
g = growth
BREAKING DOWN 'Franchise P/E'
The major factors determining the franchise P/E are the differences between the return on the new opportunity and the cost of equity. Investors should consider the growth rate and how long growth can be sustained, as well as the feasibility of the estimates (after all, they are expectations and not reality).