There are multiple stock valuation methods. The price-earnings (PE) method is one of the most popular....

There are multiple stock valuation methods. The price-earnings (PE) method is one of the most popular. The PE method is provided by the Wall Street Journal in all of its stock quotations. The PE logic is that future earnings are important determinants of a firm’s value. The PE method has several variations which can result in different valuations. Discuss the assumptions underlying the calculation of the PE ratio. What are its shortcomings?

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Expert Solution

Assumptions of PE valuation in Stock Valuation is Mainly Earning are Expected be Constant and continuous ...

And Growth Rate Expected to Continue:

Growth Rate Expected to Continue: The Profit Earing Growth Ratio is an extension on the P/E Ratio and therefore makes some of the audacious assumptions that the P/E Ratio makes as well. The PEG Ratio assumes that the current rate of growth of the company is expected to continue. However, in reality trends usually last for 4 to 5 years. So by the time the analyst does figure out the trend, it would be affected by the cyclical nature of business and may have changed..

Limitations / Shortcomings are

In case of inflation PE ratio will be lower So we cannot get the clear picture of share valuation

As soon as company manipulates it's earning EPS as well as PE ratio can Falsified...

PE is taking into consideration of the past earing but value is derived for the future so PE ratio may not be ultimate valuation the share ...

jeff jeffy answered 2 months ago

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