Question

A firm has a stock price of $50 per share. The firm’s past 12 month earnings per share is $2.5 and the firm's future earning is $5 per share. The firm has an ROE of 20% and a dividend payout ratio of 50%. Given an industry average PEG ratio of 1.6, is the firm’s stock more likely to be overpriced or underpriced? A. Overpriced, because it has PEG ratio of 2 B. Overpriced, because it has PEG ratio of 1 C. Underpriced, because it has a PEG ratio of 1 D. Underpriced, because it has a PEG ratio of 2

Answer 1

Given:

Firm with an average Price/Earning-Growth(PEG) ratio of 1.6, the stock price is Overpriced, because it has Price/Earning-Growth(PEG) ratio of 1.

where;

PEG =
`(Price/Earning)/(Earning\:Grtowth\:Rate)`

Price/Earning ration =
`(Share Price)/(Earning per share)`

Reason: It can be stated that a PEG ratio of less than 1 denotes that the stock is a good investment since it is below its “fair value.”

If a PEG ratio is greater than 1 this will further means that stock is relatively expensive,and overpriced.

Therefore, the correct option is (b) Overpriced, because it has Price/Earning-Growth(PEG) ratio of 1.