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Although Financial Ratio Analysis has limitations, it is a great tool to find the problematic areas...

Although Financial Ratio Analysis has limitations, it is a great tool to find the problematic areas in the company so that managers can go back and address the problems. One of the limitations is differences in accounting standards around the world that can distort financial ratios.

Select two publicly traded US companies listed on the NASDAQ stock market and calculate each company’s P/E (Price to Earnings Ratio) and MB (Market to Book Ratio). What do these ratios tell you about how investors value these two companies’ future prospects?
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Answer #1

Let's assume two companies which we select are Pinnacle West Capital Corp And Xcel Energy Corp. Both these companies are power utilities with regulated operations and thus are considered to be in the same industry.

Now P/E ratio of Pinnacle is 10.92 and Market/book value is 1.19. Whereas, for Xcel Energy P/E ratio is 24.76 and Market/book is 2.59. Hence, considering other factors / risks to remain same it can be concluded that Pinnacle is undervalued as compared to Xcel Energy given it has lower P/E and P/B ratios. Thus investors would overweigh Pinnacle as compared to Xcel Energy.

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