Final answer:
The permanent, transitory, and value-irrelevant components of earnings each affect a P/E ratio in different ways. A higher permanent component generally leads to a higher P/E ratio.
Step-by-step explanation:
The permanent, transitory, and value-irrelevant components of earnings each affect a P/E ratio in different ways.
Permanent component:
The permanent component of earnings refers to the sustainable and consistent part that represents a company's long-term earnings potential. A higher permanent component will result in a higher P/E ratio as investors value the stability and growth potential of the company.
Transitory component:
The transitory component of earnings refers to temporary fluctuations caused by factors such as one-time events or economic cycles. It is not considered a reliable indicator of a company's future earnings. The transitory component tends to have less impact on the P/E ratio because investors focus more on the permanent component.
Value-irrelevant component:
The value-irrelevant component of earnings refers to non-operating or non-recurring items that do not reflect the core earnings of a company. These components are often excluded from the calculation of the P/E ratio as they can distort the true earnings power of the company.
Overall, a higher permanent component of earnings generally leads to a higher P/E ratio, while the impact of the transitory and value-irrelevant components on the P/E ratio is relatively lower.