Justified P/E

Justified P/E = 4.3 If actual P/E is 16, then the asset is overpriced. Completely understood! But why it’s underpriced if the actual P/E is 7?? yet it’s above the justified ratio of 4.3, so it should be overpriced as well, shouldn’t?!!

It should be.

Where did you get this question?

Kaplan V4. R.49 page 304, the paragraph below the blue box

Unfortunately, I don’t have their materials.

What’s their rationale?

Don’t know! no further explanation provided

Hi Baidar & S2000magician -

See below. This was poorly worded IMO.

"A firm has an expected dividend payout ratio of 30%, a required rate of return of 13%, and an expected dividend growth rate of 6%. Calculate the firm’s fundamental (justified) leading P/E ratio"…one will compute 4.5 (.3/(.13-.06)).

The text then says:

“The justified P/E ratio serves as a benchmark for the price at which the stock should trade. In the previous example, if the firm’s actual P/E ratio (based on the market price and expected earnings) was 16, the stock would be considered overvalued. If the firm’s market P/E ratio was 7, the stock would be considered undervalued”…

Sorry but didn’t get you! Yet the 7 market P/E > justified 4.5 thus it should be overvalued