Question

Market value ratios

Ratios are mostly calculated based on the financial statements of a firm. However, another group of ratios, called market-based ratios, relate to a firm’s observable market value, stock prices, and book values, integrating information from both the market and the firm’s financial statements.

Consider the case of Atlantic Northern Inc.:

Atlantic Northern Inc. just reported a net income of $8,000,000, and its current stock price is $36.75 per share. Atlantic Northern is forecasting an increase of 25% for its net income next year, but it also expects it will have to issue 2,200,000 new shares of stock (raising its shares outstanding from 5,500,000 shares to 7,700,000 shares).

*If Atlantic Northern’s forecast turns out to be correct and its price-to-earnings (P/E) ratio does not change, what does management expect its stock price to be one year from now? (Hint: If you choose to compute the firm’s price/earnings ratio, round its value to four decimal places.)

$32.95 per share

$36.75 per share

$24.71 per share

$41.19 per share

*One year later, Atlantic Northern Inc.’s stock is trading at $41.25, and the company reports its common equity value as $50,743,000. What is Atlantic Northern Inc.’s market-to-book(M/B) ratio?   

*Can a company’s stock have a negative P/E ratio?

Answer 1

Current Earnings Per Share (EPS) = $8000000/5500000 shares = $1.4545 per share

So, Current Price earnings ratio (P/E ratio) = $36.75/1.4545 = 25.265625

Next year's EPS = $8000000*1.25/7700000 shares= 1.2987

As the P/E is assumed to remain the same after one year

So, Next year's Price = P/E ration * next year EPS = 25.265625 * 1.2987 = $32.8125

Market value of equity = $41.25/share * 7700000 shares = $317,625,000

market-to-book(M/B) ratio = $317625000/$50743000 = 6.2594841 or 6.2595

A negative PE ratio is possible when the company or firm is making losses or negative earnings. In that situation, the PE ratio, by virtue of its definition, becomes negative. Generally, the price of stock never becomes negative and hence, the above is the only situation when PE ratio becomes negative.