I came across following question. How come next period’s earnings is used to find value of stock. Question Given current earnings of $2 per share, an expected dividend growth rate of 10% and p/e of 12.5, what is the value of stock Answer: Next period earnings is $2*1.1 = $2.2 value of stock = 12.5 * 2.2 = $27.50 I thought answer is 12.5 *2 = $25. Don’t know how to assume p/e is forward or not.

Expected PE ratio = leading PE ratio = 12.5 Therefore you have to get the EPS which is expected as well. $2 is the CURRENT EPS, which needs to be multiplied by expected dividend growth rate to derive target price of the stock.

Sondin, your preposition is perfectly ok, had it also struck me that we need to calculate the Expected Price of the stock and not the Current Price of the stock. Because I read the question with the keyword ‘expected’ applicable only to growth rate and not to the P/E ratio given How did you manage to see those invisible brackets surrounding the expected word? Or is it just problem solving experience? - Dinesh S

The Gordon growth model requires the use of _next year’s_ earnings to find _today’s_ price. Derivation: http://en.wikipedia.org/wiki/Gordon_model

@ Dinesh: I guess the outcome from our daily analysis is to identify the target price, not the current price. I think there is some missing words in the question raised by chinni234. @ DarienHacker: The Gordon growth model in your link is DDM using dividend as the factor to identify price. It is different from using PE ratio.

I don’t know what is being discussed here but if someone tells me the p/e of a stock is 20 and the earnings are 2, I’m relatively confident the price is 40 and that means the market thinks the value is 40.

That’s what kept me wondering all this while… the link goes to DDM and we all were talking about calculating forecasted price. I went back to question to see if dividend and the required return (k) was hiding somewhere, so as to fulfill the DDM equation - Dinesh S

Sondin gave us the asnwer to the question that was probably intended.