Question

1. Based on the following regression whose output estimates the forward P/E ratio for the media industry, estimate the price for CanWest if it just announced earnings of $2.75 per share and has the following known characteristics:   Beta = 1.3, Payout = 0.55, Earnings Growth = 0.07

Regression Statistics
Multiple R	0.534936
R Square	0.286157
Adjusted R Square	0.195028
Standard Error	0.038288
Observations	54
	Coefficients	Standard Error	t Stat	P-value
Intercept	14.23657	2.41333	5.89914	0.000062
Beta	-0.10747	0.136177	-0.78923	0.433942
Payout	-0.61999	0.274706	-2.25693	0.028702
Earnings Growth	5.12223	2.45351	2.087717	0.04227

2. How reliable is this estimate and how do you know?
3. Describe a rational narrative in which a high P/E ratio suggests a good investment opportunity.
4. Describe a rational narrative in which a low P/E ratio suggests a good investment opportunity.  
5. Why would the Price / Cash Flow ratio be more informative for high Beta companies during a recession than the Price / Earnings ratio? (1 mark)

Answer 1

(b). A high P/E ratio suggests a good investment opportunity because a high P/E ratio could mean that a company's stock is over-valued, or else that investors are expecting high growth rates in the future. 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. an energy company may have a high P/E ratio, but this may reflect a trend within the sector rather than one merely within the individual company. An individual company’s high P/E ratio, for example, would be less cause for concern when the entire sector has high P/E ratios.

(c).  A low P/E ratio suggests a good investment opportunity because a low P/E can indicate either that a company may currently be undervalued or that the company is doing exceptionally well relative to its past trends.

(d). Price / Cash Flow ratio be more informative for high Beta companies during a recession than the Price / Earnings ratio because the amount of cash a company is capable of generating is one of the more important measures of its health. You'll probably hear more about P/E than almost any other metric on valuation, but it can't really give you an accurate picture of a company’s ability to generate cash, which is ultimately the bottom line. The reality is that without cash, a company won’t last long. That might seem obviously simple, but many, many companies have failed simply because cash is in too short supply. So how do you use cash flow ratios to see if a company is under- or over-valued, which is the same purpose of P/E? Two primary measurements shed light on a company’s valuation.