- CFA Exams
- CFA Level I Exam
- Study Session 10. Equity Valuation (2)
- Reading 27. Discounted Dividend Valuation
- Subject 5. Gordon growth model and the P/E ratio

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**CFA Practice Question**

An analyst decides to calculate a stock's leading and trailing P/E ratios justified by fundamentals and determine the company's relative valuation based on its actual P/E ratio. The current year is 2002 and the current stock price is 32. The required rate of return is 10%.

Based on the data, the analyst should conclude that:

A. The stock is overvalued.

B. The stock is undervalued.

C. The trailing and leading P/Es produce conflicting results.

**Explanation:**Fundamentals-based Trailing P/E = (1- b) (1 + g) / (r - g) = 0.3 x (1 + 0.05) / (0.10 - 0.05) = 6.3.

Fundamentals-based Leading P/E = (1 - b) / (r - g) = 0.3 / (0.10 - 0.05) = 6.

Actual Trailing P/E = P

_{2002}/E

_{2002}= 32/4.5 = 7.11.

Actual Leading P/E = P

_{2002}/E

_{2003}= 32/2.6 = 12.31.

Both trailing and leading P/Es based on fundamentals are lower than the actual P/Es, respectively. This means that the company may be overvalued.

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**User Contributed Comments**
2

User |
Comment |
---|---|

aero |
What is the actual price earnings???? |

aero |
Sorry. I got it. |