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The P/E ratio is a primary focus for many stock market analysts. If a firm has...

The P/E ratio is a primary focus for many stock market analysts. If a firm has no growth opportunities, what should be its P/E ratio? Explain.

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Expert Solution

The price-to-earnings ratio (P/E ratio) is the ratio for valuing a company that measures its current share price relative to its per-share earnings (EPS). The price-to-earnings ratio is also sometimes known as the price multiple or the earnings multiple.

P/E ratios are used by investors and analysts to determine the relative value of a company's shares in an apples-to-apples comparison. It can also be used to compare a company against its own historical record or to compare aggregate markets against one another or over time.

In general, a high P/E suggests that investors are expecting higher earnings growth in the future compared to companies with a lower P/E.

Investors have to pay a premium for the high growth. They expect that the denominator will expand / grow at at a good pace and will justify the high initial price.

This ratio tries to tell what the market is willing to pay per to receive portion of company’s earnings per share, thus indicating the value of share in the market.

P/E is calculated as = Market Value per Share / Earnings per Share

We can see in the formulae, it include earning per share, Earning per share increase with rise in growth of the company.

If firm have no growth opportunity then investor is not ready to pay premium for buy share so it P/E Ratio is low.

Investor ready to pay high price because in future company's growth earning increase and it make investment reasonable.

So in conclusion we can say that if a firm has no growth opportunities then P/E ratio should be low.

jeff jeffy answered 1 year ago
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