Question

2) An investor is looking to invest in two companies. Company A has expected future earnings of $10 per share in year 1, $7 in year 2 and $3 from year 3-5. Company B has expected future earnings of $4 in year 1, $5 in year 2 and $6 from year 3-5. Assuming the companies both have similar risk profiles, discuss which is the better investment for them to make.

Answer 1

Solution: For deciding which is a better company to invest, one should know about some things before investing in it, such as:

1. Trends in earnings growth: Trends in company's earning growth is important. If the earnings is increasing, it's a pretty good indication that company is doing something right. Even small, regular improvement over a long period can be a positive indicator.

2. Company strength relative to its peers: Before investing, establish if there is future growth potential. Evaluating the growth of sales and earning and checking the statement of cash flows to make sure the actual earning of business is important.

3. Debt-equity ratio: Investor can use debt as an indicator of the company's financial well-being.

4. Price- earning ratio: P/E ratio is considered a major indicator of whether a stock is undervalued or overvalued. It gives insight into a stock's market value or its worth according to financial markets.

5. Dividends: A company that pays dividends is often one with a degree of stability. High dividends could also be an indication that a company isn't investing enough in itself.  

In our question, company A's trend of future earning is falling year by year while company B has maintained a growth in trend of expected future earnings, which is a positive indicator. Therefore, company B is a better investment for them to make.