Question

P/E Ratio Model and Future Price Wal-mart (WMT) recently earned a profit of $3.13 per share and has a P/E ratio of 14.22. The dividend has been growing at a 12.5 percent rate over the past few years. If this growth continues, what would be the stock price in five years if the P/E ratio remained unchanged? What would the price be if the P/E ratio declined to 10 in five years.

Answer 1

Given that:
Present value of the profit or earnings per share=$3.13
Dividend is growing at a rate of 12.5% over 5 years. So, rate of growth is 12.5%.
Number of periods in future =5 years
We need to calculate the future value.
FV=PV*(1+r)^n where r is the growth rate.
=$3.13*(1+12.5%)^5
=$3.13*(1+12.5/100)^5
=$3.13*(1.125/)^5
=$5.64
So earnings or profit per share will be $5.64 in 5 years.
Now, P/E ratio is (Price per share)/(Earnings per share)

In five years if the P/E ratio remained unchanged at 14.22 then stock price=Earnings per share*(Price per share/Earnings per share)
=$5.64*14.22=$80.2

If the P/E ratio declines to 10 in five years then the stock price=Earnings per share*(Price per share/Earnings per share)
=$5.64*10=$56.4