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Q: Suggest which stock ratio indicates to an investor that the risk related to a stock is high. Provide support for your rationale.
A: The price-to-earnings ratio (P/E ratio) is calculated as a stock's current share price divided by its earnings per share (EPS) for a twelve-month period (usually the last 12 months, or trailing twelve months (TTM)). [ Most of the P/E ratios you see for publicly-traded stocks are an expression of the stock's current price compared against its previous twelve months' earnings. A stock trading at
\$40/share with an EPS (ttm) of \$2 would have a P/E of 20 (\$40/\$2), as would a stock priced at \$20/share with an EPS of \$1 (\$20/\$1). These two stocks have the same price-to-earnings valuation - in both cases investors pay \$20 for each dollar of earnings. But, what if a stock earning \$1 per share was trading at \$40/share? Now we'd have a P/E ratio of 40 instead of 20, which means the investor would be paying \$40 to claim a mere \$1 of earnings. This seems like a bad deal, but there are several factors which could mitigate this apparent overpricing problem. ]
Expert answered|howareyou|Points 135|
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Asked 6/1/2013 9:17:07 PM
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