Haywood Yabussof, an equity analyst, is performing a P/E-based comparison of two
ID: 2640768 • Letter: H
Question
Haywood Yabussof, an equity analyst, is performing a P/E-based comparison of two telecommunications companies in early 2015. He has the following data from Ole Time Telephone Company (OTT) and Charge A Lot Telecommunications (CAL).
? OTT is priced at $75. CAL is priced at $55.
? OTT has a simple capital structure, earned $5.50 per share (basic and diluted) in 2014 and is expected to earn $6.20 (basic and diluted) in 2015.
? CAL has a complex capital structure as a result of its outstanding stock options. Moreover, it had several unusual items that reduced its basic EPS in 2014 to $2.50 (versus $3.00 that it earned in 2013).
? For 2015, Haywood expects CAL to achieve net income of $55 million. CAL has 20 million share outstanding and options outstand of an additional 5 million shares.
A. Which P/E (trailing or forward) should Haywood use to compare the two companies valuations?
B. Which of the two stocks is relatively more attractive when valued on the basis of P/Es (assuming that all other factors are appropriately the same for both stocks)?
Explanation / Answer
(A) For calculating trailing PE Ratio, Earning per share is taken of last 12 months.While, for calculating forward P/E ratio,earning per share is taken for expecting next 12 months.In this question, Expected earning per share is given. So Haywood has been used forward P/E ratio.
(B) (i) We calculating P/E ratio for 2015 of Ole Time Telephone Company.We have,
Market price =$ 75
Earning per share (EPS)=$ 6.20
P/E Ratio =Market price/ Earning per share= 75/6.20 = 12.10 times
(ii) We calculating P/E ratio for 2015 of Charge a lot telecommunciaction.We have,
Market price = $55
Earning per Share = expected earning in 2015/ Number of outstanding shares
Earning per Share = 55/25 = $ 2.20
P/E Ratio = 55/2.2 = 25 times
Since, Charge a lot Telecommunication has higher P/E ratio i.e 25 times than ole Time Telephone Company i.e 12.10 times. So, stock of Charge a lot Telecommuncation company is attractive.
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