P/E and P/S

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afranks1

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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?
 
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.
 
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
 
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.
 
afranks1 wrote: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
Click to expand...
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.)
 
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
 
afranks1 wrote: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)?
Click to expand...
[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)
afranks1 wrote:2. How is E1= Book0 * ROE1
Click to expand...
In FRA we usually calculate ROE as:
earnings / average equity
In Equity, we usually calculate ROE as:
earnings / beginning equity
 
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 ?
 
afranks1 wrote: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?
Click to expand...
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.
afranks1 wrote:2. So Net income is the same as earnings?
Click to expand...
Yes. Eggplant and aubergine.
 
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.
 
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