Question

Explain the following terms and support your answers with appropriate examples:

1. Active portfolio management
2. Leading and trailing price to earnings (P/E) ratios. Which one you think is more useful for valuation of stocks.

Answer 1

I. Active portfolio management means management of portfolio by switching of stocks regularly according to the needs of the current environment in order to maximize the overall rate of return and minimise the overall risk associated with the portfolio. This does not copy other indexes or stocks similar to other indexes in same proportion.

This is termed as a moderate to aggressive form of strategy because it is highly against passive investment and it always try to maximize its rate of return through frequent adjustment of stocks in its portfolio.

ii. Leading price to earning ratio means that forward price to earnings where the future earnings are ascertained in order to find the price to earning ratio of a company.

Trailing price to earning ratio means that it is a ratio of finding out the past performance in order to track the price to earning ratio of a company.

leading price to earning ratio or forward price to earning ratio is a better measure to find out the price to earning because it can be used for prediction purposes and valuation purposes, and it is a forward looking technique which can be used for ascertainment of whether the shares are overvalued or undervalued and this is generally used with stocks who are high growth in nature