Alice Joyner, CFA, recently developed growth expectations for Universal Foods (UF) and Low-Carb Delites (LCD). Currently UF and LCD have price-to-earnings (P/E) ratios of 18 and 22 respectively. The market index P/E ratio is 16. Based on growth duration analysis Joyner concluded that P/E ratios of 16 and 24 for UF and LCD are justified. Under these circumstances, which investment strategy is most likely to be profitable? A) Short LCD and buy UF. B) Buy LCD and short UF. C) Buy both LCD and UF. D) Short both LCD and UF. ok im a bit confused regarding the whole “justified” p/e analysis. Are we suppose to choose stocks that have LOWER justified P/E’s then than the benchmark, or HIGHER?
the answer is B justified means intrinsic
Sorry, B it is
think of it like this it is justified for you to pay 24* earnings for LCD but you can get it if you pay 22* earnings … so it’s undervalued
so if the justified P/E, P/B or what ever the relative metric is HIGHER than the current PE, P/B we go long … right?
yes it’s fundamentally justified for you to pay 12*earnings but now you p/e is 10 that means that price can still go up 2*earnings before the stock is properly priced
Nominal P/E is taking market price of the stock. It’s a given and you don’t have to do anything with it. Justified P/E is derived using the company’s financial statements. If it’s lower than the market P/E then the stock is overpriced.
florinpop…after reading your explanation…i literally went: “oohhhh…now i get it”. and i am supposed to be this stuff for a living…how embarassing.