Financial Markets and Institutions

Question One

One factor that is most common when the P/E ratios of a company are higher than the normal twenty–percent is the high growth rate of a company. P/E ratios are meant to value the companies stocks over the years. People might argue that the rate of growth does not affect P/E ratios because of the calculation. However, since P/E ratio is based on years, it means that when a company grows fast the amount of equity in stocks increases thus increasing over a short period. This means that the P/E ratios will be affected. Henceforth, when a company is growing at a faster rate than the other companies are, the P/E ratios are expected to rise since the growth is faster over a shorter period.

The other factor is the increase in the return on equity (ROE). It measures the rate at which a company attains profits from the shares that are owned by the shareholders. When the profits are high, it means that the company is attaining high equity. Therefore, this is reflected on the P/E ratios as higher than one point five. This is because due to the profits the company has started to grow faster. When companies are growing faster, the P/E ratios start to rise becoming higher than one point five.

Question Two

            The P/E ratio will remain the same if the price or the value of the share increase together with the growth rate. This is because the company will still have the same profits from the shares that they were getting. However, if the value of the shares remains the same and the growth rate increases the P/E ratio will increase. On the other hand, this is not the case; therefore, I agree with the statement that the P/E ratio will remain the same if the value of shares increases as growth rate of a company increase.

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