Question

How do you make recommendations as to whether investors should buy/shell shares based on share price estimates calculated using the P/E ratio as well as the EV/EBITDA ratios if the 2 ratios yield different results. I.e: The EV/EBITDA ratio estimates a share price lower than that of actual selling price, whereas the P/E ratio estimates the share price of the firm to be higher than that of actual selling price?

Answer 1

P/E Ratio- Price earning ratio tells how much investors are willing to pay for an earning on per dollar. P/E ratio indicates how much investors are getting in a dollar by investing one dollar in a company's stock. P/E Ratio is also called earning multiple. P/E ratio is used to know the trend of stock and also that a particular stock is overpriced or underpriced. With the help of P/E Ratio, investors take investing decisions. If P/E multiple is higher, it shows that investors are willing to pay extra to get high returns from a particular stock in the future. A lower P/E shows that stock is undervalued.

Formula: P/E Ratio = Market value of per share / Earning per share

EV/EBITDA- This is enterprise multiple that is used to calculate the value of the company. Firstly enterprise value is calculated and then earning before interest, tax, depreciation and amortization is calculated. This ratio is also used to know whether a company is undervalued or overvalued. High ratio means, company is overvalued and low ratio means, company is undervalued. S&P EBITDA multiple is 12.75 so if the ratio is below this level, it is considered good and above average.