Example: Calculating justified P/E ratio for Comtronics again Shares of Comtronics are selling for **30**. The mean analyst earnings per share forecast for next year is 4 , and the long-run growth rate is 5%. Comtronics has a dividend payout ratio of 60% and a required return of 14%. Calculate the justified leading P/E ratio. Answer: justified leading P/E = 0.6/ (0.14 - 0.05) = 6.67 times
But can I calculate the justified leading P/E by using the actual price P0=$30 and the forecast earning E1=$4 which are given? So, I obtain a different value of justified leading P/E?
justified leading P/E = 30/4 = 7.5 times
I suppose the value of 6.67 times is the correct value, so the value of 7.5 times is wrong? But why?
They’re asking for the justified leading p/e, not the market leading p/e. The price of $30 is not relevant unless they ask if the stock is over/under/fairly valued when compared to its calculated intrinsic value, which in this case would be 6.67*4 = $26.68
Be cause the key word here is Justified. The Justified Leading P/E ratio is the ratio you would expect based on the company’s fundamentals. When you reach your answer, the ratio is justified by the inputs in the equation.
When you said "justified leading P/E = 30/4 = 7.5 times", it should be "justified leading P/E = 30/4 = 7.5 times".
The conclusion from fundamentals does not necessarily represent reality, which is why they are different. Thats why some people look at actual P/E ratios to the justified one to determine if a stock is under/overpriced.
Correct. The term “justifited” specifically refers to the modified ddm formula you cited above. (just take ddm formula and divide by e). Price can become an input if they ask you to calculate the implied growth rate, required return, etc.