If one company has a higher price to earnings ratio than the other. Which company seems...

If one company has a higher price to earnings ratio than the other. Which company seems more expensive and why?

Expert Solution

Price-Earnings Ratio: Price-earnings ratio is the measure of the current market price of the share relative to its earnings. In other words, it is a measure of the amount payable by the investor to acquire the share per $ earnings available to him. Therefore it is computed as the current market price per share ÷ earnings per share. For example, if the present market price of a share is $50.00 and the EPS of the company is $5.00, then the Price-Earnings Ratio is $50.00 / $5.00 = 10 times.

Now, if one company has a higher price to earnings ratio than the other, the company whose P/E Ratio is more seems more expensive since the investor will end up paying a relatively higher amount to obtain right on same $ earning available for him. This is because the investor is bidding on the future prospects of the company with a higher P/E ratio. He is confident about the growth earnings of the company and is willing to pay more amount now than what is required if compared to other company with lower P/E Ratio

ekkarill92 answered 2 years ago

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