What may be a problem of comparing the P/E ratio of a stock to the P/E...

What may be a problem of comparing the P/E ratio of a stock to the P/E of the overall market?

Solutions

Expert Solution

P/E is given by dividing the price of a share/Earnings per share. It gives the number of times of the EPS that, the market is willing to pay for the stock. It reflects the risk of the share also as the P/E multiple changes with significant changes in risk.

Thus, the P/E of a stock reflects its earnings and total risk, the total risk comprising of systematic risk [market risk] and non-systematic risk [firm specific risk].

In contrast, the P/E of the market reflects the earnings of the innumerable assets in the market and their risk. But, the market as whole will not have any non-systematic risk as, it is a very well diversified portfolio. It then will reflect only the systematic risk. Hence, comparing the P/E of a stock with the P/E of the market will not help in assessing the earnings/risk profit of the stock. For a proper comparison, the P/E of a stock should be compared with industry P/E or some benchmark firm in the same industry..

jeff jeffy answered 1 year ago

Next > < Previous

Related Solutions

1.) A)The P/E ratio of stock A is 25. The P/E ratio of stock B is...

1.) A)The P/E ratio of stock A is 25. The P/E ratio of stock B is 45. Their expected returns are the same. Why is the P/E ratio of stock B higher than that of stock A? B) The P/E ratio of stock A is 25. The P/E ratio of stock B is 45. Their expected growth rate is the same. Why is the P/E ratio of stock B higher than that of stock A?

Value of Stock and P/E Ratio

Castle-in-Sand generates a rate of return of $20 \%$ on its investments and maintains a plowback ratio of $0.30 .$ Its earnings this year will be $\$ 4$ per share. Investors expect a $12 \%$ rate of return on the stock. Required: (a.) Find the price and $\mathrm{P} / \mathrm{E}$ ratio of the firm. (b.) What happens to the P/E ratio if the plowback ratio is reduced to 0.20? Why? (c.) Show that if plowback equals zero, the earnings-price ratio,...

Value of Stock and P/E Ratio

Castle-in-Sand generates a rate of return of on its investments and maintains a plowback ratio of Its earnings this year will be per share. Investors expect a rate of return on the stock. Required: (a.) Find the price and ratio of the firm. (b.) What happens to the P/E ratio if the plowback ratio is reduced to 0.20? Why? (c.) Show that if plowback equals zero, the earnings-price ratio, E/P, falls to the expected rate of return on the stock.

What determines the price of a share of stock? Discuss what the P/E ratio is and...

What determines the price of a share of stock? Discuss what the P/E ratio is and the importance of the PE ratio. Choose a company and explain what the P/E ratio of that company means.

What is a P/E ratio, and why is it important in stock valuation? Choose a company...

What is a P/E ratio, and why is it important in stock valuation? Choose a company stock, and discuss its P/E ratio. Do you believe the P/E ratio provides an accurate assessment of the company’s performance?

What is 1. P/E ratio 2. Market-to-Book ratio

1. For this question we will be using P/E ratio. To find a company's P/E ratio,...

1. For this question we will be using P/E ratio. To find a company's P/E ratio, use www.morningstar.com , enter the Johnson and Johnson stock symbol (JNJ) and request a basic quote. Once you have the basic quote, the P/E ratio is listed on a front page under Key Stat. Compare the P/E ratio of your company with the industry average. Is there a difference between these two numbers? Is the stock overvalued, undervalued, or properly valued? Why? In accordance...

What does a P/E Ratio indicate? Explain how you would feel about seeing a P/E ratio...

What does a P/E Ratio indicate? Explain how you would feel about seeing a P/E ratio of 188 for a company Explain how you would feel seeing a P/E ratio of 9 for a company Be sure to cover all three questions in your answer

One measure of the value of a stock is its price to earnings ratio (or P/E...

One measure of the value of a stock is its price to earnings ratio (or P/E ratio). It is the ratio of the price of a stock per share to the earnings per share and can be thought of as the price an investor is willing to pay for $1 of earnings in a company. A stock analyst wants to know whether the P/E ratios for three industry categories differ significantly. The following data represent simple random samples of companies...

4. The table below presents the historical P/E ratio for Apple Inc. The P/E ratio increased...

4. The table below presents the historical P/E ratio for Apple Inc. The P/E ratio increased from 2002 to 2003, and then decreased for a few years. a. Please explain how the increase and decrease of P/E ratio reflect investor view about Apple. (2 points) b. The current P/E ratio of Apple is 33.7. If we use the past 10 years average P/E ratio (from 2010-2019) as a benchmark, is Apple currently underpriced, fairly priced or overpriced? Please explain. (3...

Subjects