Company A is expected by analysts to generate Earnings Per Share (EPS) in 2020 of $4.10....
Company A is expected by analysts to generate Earnings Per Share (EPS) in 2020 of $4.10. Company A's stock price is $50 per share.
Company B is expected by analysts to generate Earnings Per Share (EPS) in 2020 of $1.25. Company B's stock price is $75 per share.
*Calculate the Price-to-Earnings (P/E) ratio based on 2020 estimated earnings for Company A and Company B.
*Why in general might Company B's P/E multiple be higher than Company A's?
*If you knew something about Free Cash Flow (FCF) for each Company, why in general might that be important as you analyze the stock prices of each Company?
Homework Answers
Answer to Question 1
The formula of price earning ratio= Market value of the shares / Expected earning per share. Based on the valuation for the both the mentioned company the price to earning ratio of Company A is 12.19 and Company B is 62.5. The detailed calculation is shown in the attached excel file along with the formula involved in it.
Answer to Question 2
In general, the P/E ratio of Company B is higher than that of Company A which automatically reflects that financial performance of Company B is higher than A based on the 2020 estimation. Potential investors are much more interested in Company B to that of Company A and investors are ready to pay more for shares in the business of Company B than that of Company A due to the future growth of the business in terms of performance.
Answer to Question 3
Apart from the free cash flow in the business it is quite important to analyze the stock prices of the company. When the stock price of a particular company is higher in terms of the business compared to that of the other company, then it suggests that the future performance of the company will grow and prosper accordingly. Significant suggestion for the potential investors is to analyze the stock prices of the company along with the other factors which may affect the performance of the company by utilizing the tools and techniques.
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