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In: Finance

1.) A)The P/E ratio of stock A is 25. The P/E ratio of stock B is...

1.)

A)The P/E ratio of stock A is 25. The P/E ratio of stock B is 45. Their expected returns are the same. Why is the P/E ratio of stock B higher than that of stock A?

B) The P/E ratio of stock A is 25. The P/E ratio of stock B is 45. Their expected growth rate is the same. Why is the P/E ratio of stock B higher than that of stock A?

Solutions

Expert Solution

PE ratio is generally used as an indicator of future prospects of the company. PE ratio is the relation of market price of share, as a multiple of the Earnings Per Share (EPS). A high PE ratio is an indication of increased price from the positive market sentiment for the share.

A)When expected returns are the same for A&B, PE ratio of B was higher than A because the investors perceive stock B to be a better investment than A and are willing to pay a higher price for B than A.

B)When expected growth rate is same for A & B, this does not mean that the growth potential as perceived by the investors will be same. If the investors perceive stock B to be a better investment than A, it could be valued at higher price per its earning than stock A.Also the same expected growth rate does not mean the earning of both companies are the same. A higher PE ratio for B compared to is possible if B has lower earning than A or if B has higher price (either option is possible with samee expected growth rate)

jeff jeffy answered 10 months ago
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