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I read in a book that price earning ratio has a tendency to stay same. It is ” market share price/ earnings per share. It should be that earning per share influences share price and its increases or falls by the same percentage.
Now I am wondering: earning per share is “dist. profit to ordinary shareholders/average number of shares ordinary”.
So what if company intend to restrict the business. It sells non current assets. Depreciation decreases there are proceds from sale . ( let’s say proceeds are higher that net present value. ) It causes higher profit and higher earning per share.
I suppose the previous reasoning should be correct. But here what happens with market price of shares.
the statement that P/e ratio stays constant suggest that market price should rise.
but it’s clear that profit from this year is not sustainable and should fall in next years. But is market share price sensitive to the information about what caused higher profit. Obvious seems that market price should stay at the same level or decrease and P/E ratio decrease as well.
Can you comment on that ?
In future, if you want me to answer then you must ask in the F9 Ask the ACCA Tutor Forum. This forum is for students to help each other.
The market price (and therefore the PE ratio) depends on investors expectation of future growth. If they expect high growth in the future then they will pay more for the share – the PE will be higher. If they expect low growth in the future, they will pay a lower price for the share – the PE will be lower.
The market price is always based on future expectations rather than the current EPS.
For your book to say that PE ratios have a tendency to stay the same is silly (unless it qualified the comment). PE ratios in practice do change with events. If expectations of future growth stay the same, then and only then, will the PE ratio tend to stay constant.
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