- P/E Ratio stands for Price-Earnings Ratio. The variables that affect P/E ratio are market price of a share. Market price of the share is what it is trading at the stock exchange. The second variable that affects the P/E ratio is the Earning Per Share. Earnings per share are calculated by dividing the Net Profit after Interest and Taxes divided by the number of shares outstanding. All of these calculations reveal how much the firm is valued in terms of stock valulation.
- Stock valuation uses the time value of money in the calculation. There are several concepts of the time value of money that are used in the stock valuation. For example, in the Dividend Growth Model or Gordon Growth Model usually the future dividend is discounted to the present value along with the price of the share at terminal value to obtain the current price of the share. It is an important concept of the time value of money used in the stock valuation. It must be remembered that it will have great implications for the decision makers trying to determine when to buy and when to sell shares in the stock market.
- A negative earnings figure of a company does not mean that it is a total failure and investment in its share is futile. There might be certain temporary issues that might be affecting the company’s earning and in the long run, it may have a good potential for growth. Since, the company is unprofitable, it may not be able to pay dividends at this moment, and it will not be a good option to value a company by dividend growth model or by looking at its profitability that may be negative. However, investors can value this company by looking at its future projection of growth. They can also value it by using EBITDA figure. EBITDA figure is used in the calculation of the firm’s value by dividing enterprise value with EBITDA. Only this valuation will show the true value of the firm and will give better valuation results when valuing a company that has not much to show in its profit and loss statement.
- Random walk refers to the facts that the price changes have same distribution and past prices cannot be used to predict the future price. In other words, it is not very easy to use past trend and translates them into future price. The reason being that the event and market conditions might have been changed, and there are various other factors that might be affecting the market prices. Efficient markets are those markets that change according to the new information. Any market that does not respond to the new market news or information does not indicate an efficient market. An efficient market is one which is affected by the news or new information that becomes available. A stock market can either be weak, semi strong and strongly efficient markets. Fundamental analysts make their decision regarding the future prices and issue recommendations based on past earning and growth rates. Technical analysts base their recommendation on trading volumes. A weak and semi-strong form of efficient market hypothesis reject the idea of efficient market. These analyses are of value in the markets that are strongly efficient.
