Question

Stock Valuation and PE Sunset Corp. currently has an EPS of $4.25, and the benchmark PE for the company is 19 . Earnings are expected to grow at 5 percent per year. a. What is your estimate of the current stock price? b. What is the target stock price in one year? c. Assuming the company pays no dividends, what is the implied return on the company's stock over the next year? What does this tell you about the implied stock return using PE valuation?

Answer 1

To estimate the current stock price, we can use the Price-to-Earnings (PE) ratio. The estimated current stock price is $80.75 per share. The target stock price in one year would be $84.7875 per share.

Step-by-step explanation:

To estimate the current stock price, we can use the Price-to-Earnings (PE) ratio. The PE ratio is calculated by dividing the stock price by the earnings per share (EPS). In this case, the EPS is $4.25 and the benchmark PE ratio is 19. Therefore, the estimated current stock price is $4.25 x 19 = $80.75 per share.

To find the target stock price in one year, we need to consider the expected growth rate of earnings. Given that the earnings are expected to grow at 5 percent per year, we can multiply the current stock price by 1 + the growth rate (1 + 0.05 = 1.05) to get the target stock price. So, the target stock price in one year would be $80.75 x 1.05 = $84.7875 per share.

Since the company pays no dividends, the implied return on the stock over the next year is equal to the percentage increase in the stock price. In this case, the implied return would be ($84.7875 - $80.75) / $80.75 = 0.05, or 5 percent. This tells us that the implied stock return using the PE valuation is equal to the expected growth rate of earnings.