I think it should be overvalued.
Please add comments
Robert Chan comments to Leslie Singer that Converted Industries’ expected dividend growth rate is 5.0%, dividend payout ratio (g) is 45%, and required return on equity (r) is 10%. Based on a justified trailing P/E ratio compared to the stock’s trailing P/E ratio at market of 9.0, Converted Industries is most likely:
A) overvalued. B) correctly valued. C) undervalued.
Your answer: A was incorrect. The correct answer was C) undervalued.
Justified trailing P/E = payout ratio * (1 + g) / (r − g). When the expected dividend growth is 5.0%, the justified trailing P/E = 0.45 * (1 + 0.05) / (0.10 − 0.05) = 9.45. This is greater than the market P/E of 9.0.