a) Companies A and B have P/E ratios of 12 and 15 respectively. What information is...

a) Companies A and B have P/E ratios of 12 and 15 respectively.

What information is contained in PE ratios?

Which firm A or B would you prefer to invest in? Why? (5 marks

Solutions

Expert Solution

What information is contained in PE ratios?

Answer: P/E Ratio- Price earning ratio shows the relationship between price of stock and earning per share. It shows how much shareholders are willing to pay for per stock and how much they are earning on the same stock.S&P's P/E ratio ranges between 13 to 15. Higher P/E means that stock is overvalued and investors expect high growth in the company while lower P/E ratio means that stock is undervalued and good to buy at current levels.

P/E Ratio = Price per share / Earning per share

Example: ABC Inc.'s current price per share is $80 and EPS is $6.5 then company's P/E Ratio is 80/6.5 = 12.31 times

Which firm A or B would you prefer to invest in? Why?

Answer: This shows that stock A is 12 times trading than its earnings and stock B is 15 times trading than its earnings.

I will prefer firm A because its P/E Ratio is lower than firm B's P/E ratio that shows stock of firm A is cheaper as compare to firm B. Firm A's stock may be undervalued also.

jeff jeffy answered 1 year ago

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