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Hello, regarding the P/E ratio, in comparing 2 companies within the same industry, if A has a ratio of 8 and B has 10, which is better and why? I am asking because I’m reading something here which says that investors would expect the the earnings from B to rise at a faster rate. I thought it would have been A since the p/e ratio would represent the amount of time taken for the the earnings to equal the price paid for it.
It is investors who determine the market value of a share and the price they are prepared to pay for it is determined by the dividends that the expect in the future.
Just suppose there were shares in two companies that both had the same earnings per share at the moment.
You do not expect the earnings of the first company to grow in the future (and therefore do not expect the dividends to grow.
However you expect the earnings of the second company to grow a lot in the future (and therefor expect the dividends to grow in the future).Surely, you would expect to have to pay more for the second share?
The PE ratio is calculated using the latest earnings and so the second company would have a higher PE ratio.
A higher PE ratio does not actually mean it is ‘better’ – you get what you pay for.
It means that shareholders are expecting higher future growth.Usually companies in the same industry have similar PEs. It is different industries where you would expect different PEs.
(You will not be expected to say much about PEs in paper F5. It is in Paper F9 that they become much more important.
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