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Fake Company Theta has EPS of 3.03, a current P/E ratio of 32.1, and a relative...
Fake Company Theta has EPS of 3.03, a current P/E ratio of 32.1, and a relative P/E of 4.01. What is an estimate for the broad market (such as S&P 500) P/E?
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Expert Solution
Absolute P/E, which is the most quoted of the two ratios, is the price of a stock divided by the company's earnings per share (EPS). This measure indicates how much investors are willing to pay per dollar of earnings.
The relative P/E ratio, on the other hand, is a measure that compares the current P/E ratio to the past P/E ratios of the company or to the current P/E ratio of a benchmark.
As per question situation , Relative P/E ratio in formula = P/E Ratio of company / P/E Ratio of benchmark
4 = 32.1 / P/E Ratio of benchmark
so, Benchmark P/E Ratio =32.1 / 4 i.e 8.025
Continuing with the question above where we have a current P/E ratio of 32.1 and the relative P/E of the company to the index is therefore 4.01 . This shows investors that the company has a higher P/E relative to the index, indicating that the company's earnings are more expensive than that of the index.
A higher P/E, however, does not mean it is a bad investment. On the contrary, it may mean the company's earnings are growing faster than those represented by the index.
source - Investopedia used for definitions.
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