Question

A share trades at a price-to-book ratio of 0.7. An analyst who forecasts an ROCE of 12 percent each year in the future, and sets the required equity return at 10 percent, recommends a hold position. Does his recommendation agree with his forecast

Answer 1

The analyst's recommendation to hold the stock is consistent with their forecast, considering the stock is potentially undervalued with a price-to-book ratio of 0.7 and is expected to achieve a ROCE of 12%, higher than the required equity return of 10%.

Step-by-step explanation:

The recommendation of the analyst to hold the stock, given the information provided, seems to be consistent with his forecast. First, the stock trades at a price-to-book ratio of 0.7, indicating that it is possibly undervalued since a ratio below 1 suggests that the stock price is less than the company's actual book value per share.

Further, the analyst expects the company to achieve a Return on Capital Employed (ROCE) of 12%, which is higher than the required equity return of 10%. This implies that the company is expected to generate returns greater than the cost of its capital, which is a positive indicator of its profit-generating capability and could eventually lead to an increase in stock value.

Considering these factors, the analyst's recommendation to hold implies that the stock is expected to perform at least in line with the required return, if not outperform it, which aligns with the expectation of a 12% ROCE.

Answer 2

It does not agree.

Step-by-step explanation:

The company expects to earn ROCE higher than the required rate of return. If this is to be achieved, the company must trade at a premium value in the share market. But as the current price-to-book ratio indicated that the market value is lower than the book value, this indicate that it is a Buy position as the share is undervalued. Therefore, it does not agree with the company's recommendation.