Question

For question 2.3

Do I buy the stock or do not buy? Im not sure if i go by Walmarts pe ratio (23.83) being greater than industry average 20 (buy) or go by $100 being less than 119.83 (do not buy)

walmarts pe ratio is 23.83

2. Use the following three methods to determine if you will purchase this stock at current market price. Assume market interest rate (r) as 12%, constant dividend growth rate (g) as 10%, and industry average P/E ratio as 20 times (1) True value method (Gordon dividend valuation model) TV-DO(119) = 212(1+30%) = $116.6 TV ($116.6) < MKT ($119.13) = Do not buy because the price is overvalued (2) Annual rate of return method (Gordon dividend valuation model) DO(1+9) - 2.12(1+10% + 10% = 11.96% 11.96% < 12% - Do not buy (3) P/E multiples approach Estimated EPS 2020 * Industry Average PE 5.20 = 100 $100 < $119.13, Not buy Stock is currently trading at P/E of 23.83. Industry average is 20 thus it is showing that there is potential growth compared to industry. Should buy 3. If you purchased this stock at 52 week range low, sold it at current market price, and you also received dividend during this holding period; calculate holding period rate of return. If one bought this stock at 52 week low, then HPR (Ending Price-Beginning Price) Dividends 125.38-85.7842.12 Beginning Price HPR is 48.64%

Answer 1

In the computation as per first two models, it is already evident that the stock is overvalued.

P/E ratio is nothing but a price to earnings ratio.If the PE ratio of a company is higher than the average industry , it points towards two reasons. First, it could be a result of the company showing a huge growth and earning potential as compared to other industry players. Second, it could be due to overvaluation of the company stock by market. If the stock is overvalued then it is quite normal that you get a PE higher than average. It does not indicate it is the right choice to invest in.Hence if you are taking into consideration all the factors the appropriate decision would be not to buy it.