Question

If a companies Price/Earnings Ratio was 13.2% in 2012 and increased to 15% in 2013, but their price book ratio was 1.9 in 2012 and 0.95 in 2013, it seems like this information is contradicting itself. What does this mean? My understanding is that P/E ratio was what investors thought about the companies future performance and Price/Book Ratio is what investors thought about the companies future prospects.

Answer 1

Given that PE ratio in 2012 = 13.2

and PE ratio in 2013 = 15

Also, PBV ratio in 2012 = 1.9

and PBV ratio in 2013 = 0.95

In both the above ratios, the numerator is Price ie the expected value preceived by investors given the growth prospects and risk.

The denominator in PE ratio is Earnings per share ie how much the investors perceive the growth in cash flows or earnings with respect to the present earnings. So investors are ready to pay 13.2 times the earnings in 2012 and 15 times the EPS in 2013. ie investors perceive a higher growth in earnings.

The denominator in PBV ratio is Book value per asset ie the Net of Assets and liabilties or Equity. The reason for decrease in PBV could be attributed to higher rate of growth in Book Value of assets compared to EPS. So the assets might have grown much higher in 2013 and much faster than EPS growth in 2013, hence PBV had dipped in 2013.