Company Analysis and Company Valuation Methods Flashcards
How isP/E ratio used and interpreted by investors?
The P/E ratio is a widely used tool for stock analysis and investment decisions. Investors use this ratio for their own perceptions about the market and make decisions to buy or sell accordingly. The P/E ratio is compared with those of its competitors and with the industry average.
The P/E ratio gives a stock market view of the quality of the underlying earnings. Generally, a high P/E ratio indicates that investors anticipate higher earnings and higher growth in the future. The average market P/E ratio is 20-25 times earnings. A loss-making company does not have a P/E ratio. However, a company with a high P/E ratio can also indicate that the share is being overvalued. If a company has a high P/E, investors are paying a higher price for the share compared to its earnings.
A company with a low P/E may indicate undervalued shares. This makes a company with a low P/E a good value investment with the potential opportunity to be profitable, but it can also simply indicate that investors aren’t very confident about the company’s future prospects.
The P/E ratio shows the number of years it would take for the company to pay back the amount paid for the share.
What is the significance of identify value drivers in SVA?
Value drivers are factors that drive a business, which in return creates value in a company. These factors impact a company’s future cash flow and the value of its NPV. Shareholder value analysis helps the management to focus on factors which create value to the shareholders, rather than on short-term profitability. Key value drivers include:
- growth in sales
- improvement of profit margin
- investment in fixed assets or fixed capital
- investment in working capital
- cost of capital
- tax rate
Managers are required to pay attention to decisions influencing the value drivers and its ultimate impact on value creation.
