Question

Question 1:

Please describe the major differences between fundamental analysis and technical analysis.

Question 2:

How do you respond to the statement that a firm can improve its P/E ratio by increasing its plowback ratio (i.e., distributing less common stock dividend) so to increase its dividend growth rate?

Question 3:

Suppose a firm’s ability to pass inflation to its customers deteriorates. What will happen to the firm’s P/E ratio, increase, or decrease, and why?

Answer 1

Q - 1

Both the fundamental analysis and technical analysis are research methodology aimed at price discovery. However, there are fundamental differences between them as shown in the table below:

Q - 2

My response will be negative.

A firm may / may not / need not improve its P/E ratio by increasing its plowback ratio (i.e., distributing less common stock dividend) so to increase its dividend growth rate.

If the firm doesn't have good growth opportunities, retaining the money into the business can be value destroying. Hence, retention may not always translate into higher P/E.

Q - 3

If the firm is no able to pass on the inflation in the costs to the customers, it will have to absorb the same. This will adversely impact their margins and hence their EPS will go down. Reduction in EPS will transalte into fall in the prices. The fall in prices will be rapid and dispropotionately higher than the decline in EPS. Hence, P/E will decrease.