Which of the following statements about the P/E ratio (Price-to-Earnings ratio) is/are correct?
a. The P/E ratio is calculated by dividing the current market price of a stock by its Earnings Per Share (EPS).
b. A high P/E ratio indicates that investors are expecting higher future growth in earnings.
c. A low P/E ratio indicates that stock is overvalued.
d. The P/E ratio is primarily used to evaluate the liquidity of a company.
Which of the following statements about the P/E ratio (Price-to-Earnings ratio) is/are correct?
a. The P/E ratio is calculated by dividing the current market price of a stock by its Earnings Per Share (EPS).
b. A high P/E ratio indicates that investors are expecting higher future growth in earnings.
c. A low P/E ratio indicates that stock is overvalued.
d. The P/E ratio is primarily used to evaluate the liquidity of a company.
a only
a and b only
b and c only
a, b and d only
The Correct Option is B
Solution and Explanation
Statement a (Correct): The P/E ratio formula is $\text{Price per Share} / \text{Earnings Per Share (EPS)}$.
Statement b (Correct): A high P/E usually means the market expects high growth in the future, so investors are willing to pay more today.
Statement c (Incorrect): A low P/E does not automatically mean a stock is "undervalued"; it could mean the company is in decline or has low growth prospects. Evaluation depends on industry averages.
Statement d (Incorrect): P/E ratio evaluates valuation and growth, not liquidity. Liquidity is measured by ratios like the Current Ratio or Quick Ratio.
Correct Option: (2) a and b only
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