Last minute questions

CFA Level II Equities
#1

  1. If the Forward PE > Trailing PE the stock is overvalued. Why is this?

  2. Why do we adjust the dividend payout ratio by growth rate (1-b * 1+g ) / (r - g) in order to get the trailing PE?

#2

Inline

#3

  1. Where did you see this? I don’t think that this can be concluded just from the information given here.

  2. The trailing P/E formula is a derivation of the GGM i.e.P0 = D1/(r-g). As GGM uses D1 we need to multiply by (1+g)

To derive trailing P/E from the GGM, divide both sides of the GGM by E0:

P0/E0 = [D0(1+g)/E0]/(r-g)

Given that D0/E0 = (1-b)

P0/E0 = (1-b)(1+g)/(r-g)

Edit: Now that I can see your full post in the above quote it’s possible that my message was not at all helpful. Apologies if that’s the case!

#4

in theory, the trailing P/E has to be greater than the forward P/E

trailing P/E:

Po=(Do(1+g))/(k-g)

Divide both side by Eo, we have Do/Eo-----> payout ratio (1-b). therefore, Po/Eo= (1-b)(1+g)/(k-g)

forward P/E

divide both side by EPS1, we have Do(1+g)/E1-----> payout ratio. therefore, Po/E1= (1-b)/(k-g)

In conlcusion, the trailing P/E is always has to be greater than the forward P/E. if this does not hold, the security is mispriced

#5

The assumption is holding everything else constant ,and that includes industry, company, economy

For example, during recession, E1

#6

Thanks