Question

1.Why are common stockholders considered to be more at risk than the holders of other types of securities?

2. What does it mean when a company has a very high P/E ratio? Give examples of industries in which you believe high P/E ratios are justified.

Answer 1

1. In the hierarchy of lenders to the firm, the common stockholders are at the bottom of the table. In an event of bankruptcy of the firm, the common stockholders are to be paid at the last after all settlements have been made. In certain cases they do not receive back their investment or receive less than the money they have put in. This places them at a very high risk when compared to other securities.

2. A high P/E may indicate that the investors expect the firm's earnings to grow in the future. Alternatively it can be indicative of low earnings per share and the investors anticipate that the firm will recover soon. Industries where in high P/E ratio is justified include energy and oil, FMCG and technology. The reason being these are essentials without which the economy would not survive and a dull earnings can turnaround quickly in these sectors and the high P/E ratio is justified.