Question

If we divide each side of the equation by the firm’s earnings per share, we arrive at a P/E ratio for which we could use to compare firms which have similar P/E multiples. However, this begs the question of just how comparable these firms are to each other. Explain how each of those determinants plays a part across supposedly similar firms.

P=EPS/i + NPVGO

-A number of publicly traded firms pay no dividends yet investors are willing to buy shares in these firms. How is this possible? Does this violate our basic principle of stock valuation? Explain.

-What is the difference between the EV/EBITDA ratio and the PE ratio?

Answer 1

1. COst of equity might not be the same across comparable firms because of different beta (diff capital structure, operating leverage, etc.)

Growth opportunities might be different
Dividend Payout ratio might not be the same

2.

Returns comprise of income and capital appreication. So for stocks which dont pay any dividends, income is zero and hence the returns would only come from capital appreciation. This does not violate basic principle of stock valuation, it is just that we cannot use DIvidend discount model to value such stocks. The company is reinvesting its earnings in proftable projects and the benefit would be captured in share price.

3.

EV/EBITDA uses total value of the firm while PE uses share price or common stock only

EV/EBITDA uses Earnings before interest taxes and depreciation while PE uses net income or income after interest, taxes and depreciation