Question

4-10 Refer to an online finance source such as Yahoo! Finance or Google Finance to look up the P/E ratios for Alphabet Inc. (the parent company of Google), and Walmart. Which company has a higher P/E ratio? What factors could explain this?

Answer 1

P/E ratio of Alphabet inc is 22.58 and Walmart is 21.11, Alphabhet inc is having a higher P/E ratio.

The price-earnings ratio is the ratio of a company's share (stock) price to the company's earnings per share. The ratio is used for valuing companies and to find out whether they are overvalued or undervalued. It is also known as the price multiple or the earnings multiple. P/E ratios are used by investors and analysts to determine the relative value of a company's shares. It can also be used to compare a company against its own historical record or to compare aggregate markets against one another or over time.

A high P/E ratio could mean that a company's stock is over-valued, or else that investors are expecting high growth rates in the future. Companies that have no earnings or that are losing money do not have a P/E ratio since there is nothing to put in the denominator.

A higher P/E Ratio shows willingness of market to pay more for the company’s earnings. Some investors read a high P/E as an over-priced stock, which may be the case sometimes. However, it can also indicate that the market has high hopes for the share’s future and has bid up the price.

A low P/E Ratio may indicate ‘vote of no-confidence’ by the market which means that the investors have undervalued the stock due to lack of confidence in its future growth. However, it could also mean that this is a stock which has been overlooked by the market and does possess strong future growth potential. If this is the case, they are considered value stocks and investors sometimes make their fortunes spotting these ‘diamonds’ before the rest of the market discovers their true value.

There are certain Factors affecting P/E Ratio, they are

Growth – Better the growth prospects of the company, the more willing people are, to be a part of that company by paying more per rupee of earning.

Risk – The higher the risk, the lesser inclination people would have; to invest in equity shares thus affecting share price to an extent.

Past Track Record – Track record is a major factor that determines consumer trust and willingness to invest in a particular company.

Government Vision – Government’s approach and vision for a particular industry and company affects the P/E Ratio. Government restrictions on certain industries affects business of a company and hence its share price.

Performance of Economy – General effects on economy; for e.g. monsoon etc. impacts company performance. A good monsoon leads to higher productivity, growth in economy and will reflect on the stock’s P/E ratio.