Question

Although Financial Ratio Analysis has limitations, it is a great tool to find the problematic areas in the company so that managers can go back and address the problems. One of the limitations is differences in accounting standards around the world that can distort financial ratios.

Select two publicly traded US companies listed on the NASDAQ stock market and calculate each company’s P/E (Price to Earnings Ratio) and MB (Market to Book Ratio). What do these ratios tell you about how investors value these two companies’ future prospects?

*Make sure your selected companies are different than your classmates’.

Answer 1

Two selected companies are:

Company 1 : Intel

Company 2 :Cisco systems

We know

INTEL

Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)

P/E of 11.31 = $49.48 ÷ $4.37

Where Last trade price : 49.48

Eps reported : 4.37

Market to book ratio for Intel is 2.57. ( 49.48÷19.25)

CISCO SYSTEM

P/E RATIO 12.62. ( 39.81÷3.1)

And

MB ratio for Cisco 4.4 ( 39.81÷8.95)

A higher P / E ratio means that consumers have to pay a higher price for every $1 they have received in the last year. That's not inherently good or bad, but high P / E means reasonably high expectations about what a business will do in the future.

Earnings growth rates have a significant effect on P / E ratios. When earnings rise, the 'E' will rise over time. This suggests that even though the present P / E is high, it will reduce over time if the share price remains stable. Then, lower P / E should draw more investors, driving up the share price.

The price-to-book ratio compares a company's market value to its book value. A high PB Ratio indicate that the company is overvalued and

Investors have high expectations out of the company than its peer companies in the same segment. Hence they are willing to pay high and it pushes the share value upward.