Question

One investor has issued a target price of $65 for A company. the normal P/E ratio in the railroad industry is 20. What is the amount of the dividend the investor need to pay one year from now?

Answer 1

Solution:-

The target price $65 for the stock, which means that the investor believes that the intrinsic value of stock is $65.

Now, the P/E ratio of industry is 20 times which means that the expected earnings for the year would be as follows:

P/E ratio= Price/EPS

20= $65/EPS

EPS= $3.25

So, if the intrinsic value of stock is $65 and desired P/E ratio is 20 times, it means that the expected EPS is $3.25 based on which the investor is arriving at the target price of $65 per share.

Now, we know the EPS but not the dividend payout ratio in the given question, therefore we must assume that the entire earnings is distributed as dividends which means that the expected dividend one year from now is equal to the expected EPS, i.e. $3.25

Therefore, the expected dividend is $3.25 for the stock.