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As dividends increase, P/E increases, because b is lower.
If k-g is constant, then as (1-b) increases, P/E increases
P/E = 1-b / k-g
P/E = 1-b / k – (ROE x b)
P/E Assuming all other factors remain unchanged, which
variable would reduce the market P/E ratio?
Remember: P/E = (1-b) / (k-g)
For P / E to decrease either the numerator
decreases, i.e. b increases.
Or the denominator increases, i.e. k increases or g
For g to decrease ROE has to decreases. Rationale for using P / E ratios:
Earning power, as measured by EPS is the
primary determinant of investment value.
Investment community uses P/ E ratio
Empirical research shows that P/E differences
are scientifically related to long-term average
stock Drawbacks to P/E analysis
Earnings can be negative.
Difficult to interpret as due to price volatility.
Management can distort earnings, making it
difficult to compare P/E among firms.
difficult Rationale for using P / BV
P/BV = market price per share / BV per share(1)
BV per share = BV of the equity(1) / # of shares
Book value is typically positive
BV is more stable than EPS
P/BV is good for valuing firms that may go out of
P/BV linked to differences in L/R stock returns
differences Drawback to P/BV
Does not recognize non-physical assets
May be misleading when there are significant
differences in asset size
Inflation and technology can lead to big
differences in book & market values
differences Rationale for using Price/sales
P/S = Market price per share / Sales per share
Meaningful even for distressed firms, since
sales is always positive
Sales not easy to manipulate
Not as volatile as EPS Drawbacks to P/Sales
High sales growth does not necessarily
indicate high operating profit
Doesn’t capture different cost structures
Distortion is still possible given different
revenue recognition practices
revenue Company Analysis and Stock Selection
Steps in establishing the value of a company:
Find the P/E
Put a value on the stock =( EPS) (P /E)
Make an informed investment decision E(R) >K...
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