One of the more closely watched ratios by investors is the price/earnings or P/E ratio. By dividing price per share, analysts get insight into the value the market attaches to a company's earnings. More specifically, a high P/E ratio (in comprasion to companies in the same industry) may suggest the stock is overpriced. Also, there is some evidence that companies with low P/E ratios are underpriced and could tend to outperform the market. However, the ratio can be misleading.
P/E ratios are sometime misleading because the E(earnings) is subject to a number of assumptions and estimates that could result in overstated earnings and a lower P/E. Some analysts conduct "revenue analysis" to evaluate the quality of an earnings number. Revenues are less subject to management estimates and all earnings must begin with revenues. These analysts also compute the price-to-sales ratio (PSR = price per share/sales per share) to assess whether a company is performing well compared to similar companies. If a company has a price-to-sales ratio significantly higher than its competitors, investors may be betting on a stock that has yet to prove itself.
a) Identify some of the estimates or assumptions that could result in ovestated earnings.
b) Compute the P/E ratio and the PSR for Tootsie Roll and Hershey's for 2006.
c) Use these data to compare the quality of each company's earnings.
Hershey's 2006 Financial Statements
Tootsie Roll 2006 Financial Statements
This solution contains explanations comparing P/E ratios for Tootsie Roll and Hershey's in 2006
Compare 9 Financial Ratios: 3M, Alcoa, Coca-Cola, Abbott Labs
Go to the Yahoo! Finance Web site.
Review the overview/main pages for the four public companies:
Research the the four firms using either Key Statistics or Financials from the overview/main pages for the stocks onYahoo! Finance Web site. Compute and compare the following financial ratios for the four firms for their most recent fiscal years:
Current Ratio (X)
Sales/Total Assets (percent) or Total asset turnover
Times interest earned (X)
Total Debt/Equity (percent)
Net Income / Net Sales (percent) or Return on Sales (ROS)
Net Income / Total Assets (percent) or Return on Assets (ROA)
Net Income / Common Equity (percent) or Return on Equity (ROE)
P/E or P/E Ratio (X)
Market to Book Value Ratio (X)
Note: In Key Statistics under the heading 'Valuation Measuresâ? there are numbers for both Trailing P/E ratios and Forward P/E ratios. Most commonly, in calculating both ratios the corporation's current stock price is divided by its earnings per share (EPS). The difference is that Trailing P/E ratios use reported EPS for the past year, specifically the past/trailing 12 months (ttm), and Forward P/E ratios use estimated EPS for the upcoming 4 quarters. Also, in interpreting some of the other statistics provided, please note that 'yoy' is an acronym for 'year-on-year' and 'mrq' is an acronym for 'most recent quarter.'
Write a paper responding to the following questions based on your research:
Compare the 9 financial ratios listed above for the four companies. It is recommended that you use a spreadsheet to demonstrate your comparison. Insert the table into your Word document and respond to the following questions:
How would you rank the four firms in terms of financial performance?
Why might their financial performances differ?
What economic or market factors might account for big differences in P/E ratios?
Select ONE of the companies and examine the trend in the ratios for the past three years. Respond to the following question:
Is the firm's performance improving, declining, stable, or is something strange going on? (Please note that you should use these ratios and their trends to assist you in responding to the action items below.)
Continue your research on the company you selected in the previous action item.
At the Yahoo! Finance main page for your company select Competitors under the heading "Company." In the table entitled 'Direct Competitor Comparison' you'll see several key financial line items for the firm along with those for select competitors and the industry as a whole.
Scroll down to see individual competitors ranked by sales with links in the column entitled â??Symbolâ? to each of their own main pages.
Write an analysis of the performance of the company you selected above. Your analysis is to include the information you gained from your research (above) and your responses to the following:
Who are the firm's competitors? Does the selection of competitors make sense to you?
How is your selected company performing against its competition? (Don't just say better or worse on particular ratios; try to think of and offer reasons why).