a A research analyst is trying to determine whether a firm’s price-earnings (P/E
ID: 3250364 • Letter: A
Question
a
A research analyst is trying to determine whether a firm’s price-earnings (P/E) and price-sales (P/S) ratios can explain the firm’s stock performance over the past year. A P/E ratio is calculated as a firm’s share price compared to the income or profit earned by the firm per share. Generally, a high P/E ratio suggests that investors are expecting higher earnings growth in the future compared to companies with a lower P/E ratio. The P/S ratio is calculated by dividing a firm’s share price by the firm’s revenue per share for the trailing 12 months. In short, investors can use the P/S ratio to determine how much they are paying for a dollar of the firm’s sales rather than a dollar of its earnings (P/E ratio). In general, the lower the P/S ratio, the more attractive the investment. The accompanying table shows the year-to-date (YTD) returns and the P/E and P/S ratios for a portion of the 30 firms included in the Dow Jones Industrial Average.
DOW
YTD return
(in %)
P/E ratio
P/S ratio
1. 3M Co.
4.4
14.37
2.41
2. Alcoa Inc.
4.5
11.01
0.78
3. American Express Co.
5.9
11.97
2.24
4. AT&T Inc.
4.8
11.28
1.35
5. Bank of America Corp.
11.4
9.81
1.82
6. Boeing Co.
20.6
15.65
0.8
7. Caterpillar Inc.
64.3
16.06
1.61
8. Chevron Corp.
18.5
8.98
1.01
9. Cisco Systems Inc.
15.5
11.36
2.76
10. E.I. du Pont Co.
48.1
13.73
1.43
11. Exxon Mobil Corp.
7.2
11.46
1.2
12. General Electric Co.
20.9
14.32
1.29
13. Hewlett-Packard Co.
18.3
8.17
0.81
14. Intel Corporation
3.1
9.5
2.67
15. International Business Machines
12.1
11.17
1.97
16. Johnson & Johnson
4
12.64
2.75
17. JP Morgan & Chase &Co.
1.8
9.68
1.99
18. Kraft Foods Inc.
15.9
13.45
1.14
19. McDonald's Corp.
22.9
14.96
3.34
20. Merck & Co., Inc.
1.4
8.93
2.38
21. Microsoft Corp.
8.4
10.53
3.7
22. Pfizer
3.7
7.91
2.2
23. The Coca-Cola Co.
15.4
16.38
4.58
24. The Home Depot, Inc.
21.2
16.29
0.87
25. The Procter & Gamble Co.
6.1
15.05
2.31
26. Travelers Companies Inc.
11.7
9.17
0.99
27. United Technologies Corp.
13.4
14.93
1.38
28. Verizon Communications
15.6
15.59
0.91
29. Wal-Mart Stores, Inc.
0.9
12.58
0.47
30. Walt Disney Company
16.3
13.94
1.94
SOURCE: The 2010 returns (January 1, 2010–December 31, 2010) were obtained from The Wall Street Journal, January 3, 2010; the P/E ratios and the P/S ratios were obtained from finance.yahoo.com on January 20, 2011.
What is the predicted return for a firm with a P/E ratio of 10 and a P/S ratio of 2? (Negative value should be indicated by a minus sign. Round your answer to 2 decimal places.)
A research analyst is trying to determine whether a firm’s price-earnings (P/E) and price-sales (P/S) ratios can explain the firm’s stock performance over the past year. A P/E ratio is calculated as a firm’s share price compared to the income or profit earned by the firm per share. Generally, a high P/E ratio suggests that investors are expecting higher earnings growth in the future compared to companies with a lower P/E ratio. The P/S ratio is calculated by dividing a firm’s share price by the firm’s revenue per share for the trailing 12 months. In short, investors can use the P/S ratio to determine how much they are paying for a dollar of the firm’s sales rather than a dollar of its earnings (P/E ratio). In general, the lower the P/S ratio, the more attractive the investment. The accompanying table shows the year-to-date (YTD) returns and the P/E and P/S ratios for a portion of the 30 firms included in the Dow Jones Industrial Average.
Explanation / Answer
(a1) Return = -33.3966 + 3.9674 * P/E - 3.3681 * P/S
(a2) Yes
(c) As the P/S ratio increases by 1 unit, the predicted return of the firm decreases by 3.37%, holding P/E constant.
(d) -0.46%
(e) 13.64
(e) 40.28% of the sample variation in y is explained by the sample regression equation.
Regression Analysis R² 0.403 Adjusted R² 0.359 n 30 R 0.635 k 2 Std. Error 13.638 Dep. Var. YTD Return ANOVA table Source SS df MS F p-value Regression 3,386.4639 2 1,693.2320 9.10 .0010 Residual 5,021.6258 27 185.9861 Total 8,408.0897 29 Regression output confidence interval variables coefficients std. error t (df=27) p-value 95% lower 95% upper std. coeff. Intercept -33.3966 0.000 P/E Ratio 3.9674 0.9587 4.138 .0003 2.0002 5.9346 0.616 P/S Ratio -3.3681 2.6294 -1.281 .2111 -8.7632 2.0271 -0.191 Predicted values for: YTD Return 95% Confidence Interval 95% Prediction Interval P/E Ratio P/S Ratio Predicted lower upper lower upper Leverage 10 2 -0.4591 -7.4555 6.5374 -29.3027 28.3845 0.063Related Questions
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