P/E and P/S

CFA Level II
#1

Referring to Schweser reading 37, concept check 15. Question is looking for justified leading P/E. First part of the answer has trailing P/E = (P/S) / net profit margin How did P/S get here?

#2

P/S = P/E x profit margin = P/E x NI/SALES

If you divide P/S by NI/Sales aka profit margin, you get P/E.

#3

I just finished an article on justified ratios: http://financialexamhelp123.com/justified-ratios-price-multiples/.

Please let me know if it’s helpful.

#4

i’m still not clear on why p/e = (p/s) / net profit margin and s2000, i think your information as written in your article is good. however, i don’t get some of the derivations in the formulas, like how did we get from the 1st line to the 2nd line of leading p/e. did we divide both sides by E1? but then doesn’t the right side of the equation become [D1 / (r - g)] / E1

#5

net profit margin = E/S

so (P/S) / (E/s) = (P/E)

it is algebraic manipulation and getting from what you have to what you need.

#6

Yes. But [D1 / (r - g)] / E1 = (D1/E1) / (r - g).

Think about it. (Toss in some numbers.)

(I added a step in the derivation that will make that clearer (I hope!). If there are any others that aren’t clear, please let me know and I’ll update them. Thanks for the feedback; the purpose of my site is to make this stuff clear.)

#7
  1. I know that it works since I’ve tossed in numbers, but how does it get to the next line, because: [D1 / (r -g)] / E1 = [D1 / (r-g)] * (1/E1), then how do we get to (D1/E1) / (r-g)? 2. How is E1= Book0 * ROE1
#8

[D1 / (r-g)] × (1/E1) = D1 × 1/(r-g) × 1/E1

= D1 × 1/E1 × 1/(r-g)

= D1/E1 × 1/(r-g)

= (D1/E1)/(r-g)

In FRA we usually calculate ROE as:

earnings / average equity

In Equity, we usually calculate ROE as:

earnings / beginning equity

#9
  1. my end derivation is D1/E1 x [1/(r-g)] = D1/ [E1(r-g)], which arrives at the same answer as (D1/E1)/(r-g). So given we get the same result, does it matter what our end derivation is? 2. So Net income is the same as earnings ?
#10

Only to the extent that D1/E1 is the dividend payout ratio, and that’s where the formula was headed. You have to be able to calculate the ratio if you’re given b, g, and r.

Yes. Eggplant and aubergine.

#11

thanks s2000!

#12

My pleasure.

#13

The equation you gave seems wrong … P/E is Price per share / Earning per share . The lower the ratio the undervalued is the asset or the security and its worth buying and vice versa . Similarly P/S is Price per share divided by Sales per share . Again the lower the ratio undervalued is the security and vice versa.

#14

Reading this article was like listening to Hilary Hahn play op. 64 Concerto in E Minor for the first time! Thank you for the explaination!

#15

Wowzer! What a compliment.

(For the record: she’s a lot cuter than I am. But I’m probably a better warhead designer.)

#16

laugh