Assume we have two firms that have the same earnings per share ($10). Firm A has a P/E ratio of 5 and Firm B has a P/E ratio of 40. Assume that investors do not expect the P/E ratio for Firm A to change over the foreseeable future.

Explain why it makes sense that over the long-run the P/E ratios of firms should converge to a similar value.

The P/E ratio of Firm B could go down if P goes down or earnings per share goes up. If you are an investor you are expecting that the P/E ratio will go down by what happening? Explain.

 

If the P/E ratio for Firm B is equal to 5 after ten years, what would earnings per share have had to go up? Show your calculations?

Answer rating: 100% (QA)

Convergence of PE Ratios in the Long Run Heres why PE ratios tend to converge over time 1 Investor Arbitrage Investors are rational and seek undervalu... View the full answer