To determine justified PE ratio you have run a regression of PE ratio against di

Question

To determine justified PE ratio you have run a regression of PE ratio against divdend payout ratio, equity beta, and expected earnings growth rate across a group a similar companies anM arrived the following results: PE = 4 + 10*(Dividend payout ratio) - 10*(Beta)+80*(Expected growth rate in EPS) (Thus, if your dividend payout ratio is 50%, beta is 2 and expected growth rate is 20%, your justified PE = 4+10*0.5-10*2+80*0.2=5). Assume that you are looking at a company that is trading at a PE ratio of 16, and has dividend payout ratio of 75%, beta of 0.75 and expected growth rate of 20%. With the regression, what will be the justified PE ratio and should you buy the company's stock or not? calculate the justified PE ratio should you buy the company the stock or not?

Explanation / Answer

Justified PE=4+(10*0.75)-(10*0.75)+(80*20%)
=25

since it is trading less than justified PE we should buy the stock as it is value stock

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