Question

Many investors value stocks without calculating expected future dividends and instead, they rely upon “multiples” that reflect how many dollars and cents an investor is willing to pay for every dollar of sales or book value or cash flow generated by the company on a per share basis. The most commonly used valuation multiple to determine the Price is the PE ratio and relies on which of the following:

Answer 1

The most commonly used method of relative valuation is price to earning ratio and price to earning ratio will always be dependent upon exposure of the company and the relative price to earning ratio of the industry and it will be trying to Multiply the Earning per share of the company with relative price to earning of the industry in order to arrive at the market price of the company.

Price to earning ratio= (market price of the company / Earning per share)

Market price of the company= (Price to earning ratio X Earning per share)

For example, if we considered the Earning per share of Apple is $4 and price to earning ratio of of relative industry is 30.

Then the market price of Apple should have been(30*4)=120, and if the current market price of Apple is $100 then there is a undervaluation of share of Apple and investor will buy it.