Question

1. A company has net profits of £20 million, a share price of £3.00 and 100 million shares outstanding. From this information, calculate its Price/Earnings ratio (4 marks) 2. If Just Eat PLC company has a P/E of 100x, which is higher than the FTSE 100's P/E of 21x, what does this tell you about how the stock market views the company's growth prospects? (5 marks)

Answer 1

Requirement 1

Price Earnings Ratio = Market Price / Earning per share = 3 / ( 20/100) = 3 / 0.20 = £15

Requirement 2

Just Eat PLC with 100x is very high compared to FTSE 100's P/E of 21x,A high P/E ratio implies that a company's stock is over-valued, or else that stakeholders are supposing high growth rates in the future.

The P/E ratio evaluayes how much investors are keen to pay for a company's earnings. Normally speaking, the higher the P/E ratio, the more investors are eager to pay for a dollar's worth of a company's earnings. Stocks with high P/Es (usually those with a P/E above 30) generally have better future growth prospects, while stocks with low P/Es (normally those with a P/E below 15) incline to have lesser future growth predictions. However, a P/E ratio by itself does not say much about a stock's valuation.

One can also match a stock's P/E with the average P/E of the entire market. However, the same restrictions of industry assessments apply to this process as well. The stock we are studying might be rising faster (or slower) than the average stock, or it might be dicier (or less risky). In general, equating a company's P/E with those of industry peers or with the market has some value, but you should not rely on these tactics to make final buy or sell decisions.