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Hi John,
I have a query:
Which of the following statements are problems in using the PE ratio to value a company?
1) It can be difficult to find a quoted company with a similar range of activities
2) A single year’s PE ratio may not be representative
3) It is the reciprocal of the earnings yield
4) It combines stock market information with corporate information.Ans in book is 1 and 2.
My question why are 3 and 4 incorrect?
If the earnings yield is the reciprocal of the PE ratio, doesn’t it follow that the PE is the reciprocal?
And for 4, if the PE uses the market price and the EPS to find it, aren’t these stock market information and corporate information respectively?My mind boggles ….
Thanks as always 🙂
3 is incorrect because although it is true that the PE ratio is the reciprocal of the earnings yield, the question asks which of the statements are problems in using it to value a company. The fact that it is the reciprocal is not a problem for anything 🙂
4 is incorrect because it takes stock market information but not corporate information (corporate information is information about things such as the company’s future plans)
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