# Question: A research analyst is trying to determine whether a firm s

A research analyst is trying to determine whether a firm’s price-earnings (P/E) and price-sales (P/S) ratios can explain the firm’s stock performance over the past year. A

P/E ratio is calculated as a firm’s share price compared to the income or profit earned by the firm per share. Generally, a high P/E ratio suggests that investors are expecting higher earnings growth in the future compared to companies with a lower P/E ratio. The P/S ratio is calculated by dividing a firm’s share price by the firm’s revenue per share for the trailing 12 months. In short, investors can use the P/S ratio to determine how much they are paying for a dollar of the firm’s sales rather than a dollar of its earnings (P/E ratio).

In general, the lower the P/S ratio, the more attractive the investment. The accompanying table shows the year-to-date (YTD) returns and the P/E and P/S ratios for a portion of the

30 firms included in the Dow Jones Industrial Average. The entire data set, labeled Dow_2010, can be found on the text website.

a. Estimate: Return = β0 + β1P/E + β2P/S + . Are the signs on the coefficients as expected? Explain.

b. Interpret the slope coefficient of the P/S ratio.

c. What is the predicted return for a firm with a P/E ratio of 10 and a P/S ratio of 2?

d. What is the standard error of the estimate?

e. Interpret R2.

f. At the 5% significance level, are the explanatory variables jointly significant?

g. At the 5% significance level, are the explanatory variables individuallysignificant?

P/E ratio is calculated as a firm’s share price compared to the income or profit earned by the firm per share. Generally, a high P/E ratio suggests that investors are expecting higher earnings growth in the future compared to companies with a lower P/E ratio. The P/S ratio is calculated by dividing a firm’s share price by the firm’s revenue per share for the trailing 12 months. In short, investors can use the P/S ratio to determine how much they are paying for a dollar of the firm’s sales rather than a dollar of its earnings (P/E ratio).

In general, the lower the P/S ratio, the more attractive the investment. The accompanying table shows the year-to-date (YTD) returns and the P/E and P/S ratios for a portion of the

30 firms included in the Dow Jones Industrial Average. The entire data set, labeled Dow_2010, can be found on the text website.

a. Estimate: Return = β0 + β1P/E + β2P/S + . Are the signs on the coefficients as expected? Explain.

b. Interpret the slope coefficient of the P/S ratio.

c. What is the predicted return for a firm with a P/E ratio of 10 and a P/S ratio of 2?

d. What is the standard error of the estimate?

e. Interpret R2.

f. At the 5% significance level, are the explanatory variables jointly significant?

g. At the 5% significance level, are the explanatory variables individuallysignificant?

## Answer to relevant Questions

There has been a lot of discussion regarding the relationship between Scholastic Aptitude Test (SAT) scores and test-takers’ family income (New York Times, August 27,2009). It is generally believed that the wealthier a ...Megan Hanson, a Realtor in Brownsburg, Indiana, would like to use estimates from a multiple linear regression model to help prospective sellers determine a reasonable asking price for their homes. She believes that the ...According to the World Health Organization, obesity has reached epidemic proportions globally. While obesity has generally been linked with chronic disease and disability, researchers argue that it may also affect salaries. ...In a multiple regression with 40 observations, the following sample regression equation is obtained: = 12.8 + 2.6x1 - 1.2x2 with se = 5.84. Also, when x1 equals 15 and x2 equals 6, Se (0) = 2.20.a. Construct the 95% ...Access the data, labeled Professor_Salary, from the text website. These data were used in the introductory case of this chapter. Recall that we estimated our preferred model as = 39.43 + 1.24x + 13.89d, where y represents ...Post your question