Equity Ratios For Investors - Growth

Question 1

Price Earnings (P/E) ratio

Answer 1

Current market share price / EPS

= number of years it would take to get your money back

• only good to compare stocks in same sector
• lower the number the better
  BUT
• low number may mean stock is cheap OR a company on the slide (may not do as well next year)
• high number may = expensive OR a growing company (may do even better next year)
• BASED ON HISTORIC DATA THOUGH

Question 2

Price Earnings Growth (PEG)

Answer 2

PE ratio / Earnings growth % (given in exam)

• Used to take historic data and forecast in forwards
• used as an indicator of stocks potential value
• lower the number the cheaper the stock

LIMITATIONS =

• uses historic data
• growth figure use is a projection and therefore is reliant on the quality of this projection

Question 3

Factors relating to price earnings ratio which could effect the market’s view

Answer 3

• future profits

- quality and consistency of earnings

Question 4

Four factors why a company’s P/E ratio may be higher than the average (4)

Answer 4

• quality and consistency of earnings
• expectation of future profits
• exceptional items in the accounts
• shares are over priced

Question 5

What is meant by a forward and a trailing P/E ratio and what is the main drawback of each (4)

Answer 5

• • forward P/E uses future earnings guidance
• it is an estimate so figures could end up being wrong
• trailing P/E uses last 12 months
• past performance not necessarily a guide to future

Question 6

Four possible reasons why P/E ratio may be higher than sector average (4)

Answer 6

• quality and consistency of earnings
• expectation of future profits
• exceptional items in the accounts
• shares are overpriced