Question

Go online and find out the following information of Walmart and Amazon: beta, earnings per share (EPS), P/E ratio, dividend yield, and market capitalization. Think about the current market value of the two companies and answer the following questions:

 1. Explain P/E ratio in an intuitive way.

 2. Explain what beta is and why it is important to security valuation.

 3. Why do you think that Amazon worth almost three times as much as Walmart even though Walmart's total earnings are much higher than Amazon's?

 4. Does P/E ratio have anything to do with valuation?

Answer 1

1) The P/E ratio stands for Price per Earnings ratio. It implies the valuation of the company or the price that the shareholders of the company are willing to pay for per share earnings of the company. The P/E ratio of Walmart is 19.90 and that of Amazon is 235.34. This implies that the investors of Walmart are willing to pay $19.90 for earning $1 from the company. For Amazon, the investors of Amazon are willing to pay $235.34 for earning $1 from the company.

2) Beta implies the volatility of the stock. It gives an idea about the movement of the stock prices when compared to the market movement. Thus, it is important for security valuation. For example: If a stock has beta less than 1 then it means that the investment in the stock will be less volatile than the market.

3) Though the earnings of Walmart are more than Amazon, the value of Amazon is more than Walmart as Amazon is reinvesting all its earnings in the business. Unlike Amazon, Walmart is giving out dividend to its shareholders from the earnings that it has obtained. So, though Walmart is earning more than Amazon, it is distributing the earnings in the form of dividends while Amazon is using the earnings only for expansion of business and acquiring other e-commerce websites. Thus, the value of Amazon is more than Walmart.

4) P/E ratio is normally used by investors to understand the company’s performance in which they want to invest. But it is not a good indicator at all times. Sometimes, the P/E ratio of some companies are unnaturally high like here the P/E ratio of Amazon is 235.34 which is abnormally high. So, investors will have to use other measures also to analyze a stock before investing. The investors decision to invest in a stock will affect its valuation.