May Stewart, CFA, a retail analyst, is performing a P/ E-based comparison of two
ID: 2805901 • Letter: M
Question
May Stewart, CFA, a retail analyst, is performing a P/ E-based comparison of two hypothetical jewelry stores as of early 2009. She has the following data for Hallwhite Stores (HS) and Ruffany (RUF).
HS is priced at $ 44. RUF is priced at $ 22.50.
HS has a simple capital structure, earned $ 2.00 per share (basic and diluted) in 2008, and is expected to earn $ 2.20 (basic and diluted) in 2009.
RUF 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 2008 to $ 0.50 (versus the $ 0.75 that it earned in 2007).
For 2009, Stewart expects RUF to achieve net income of $ 30 million. RUF has 30 million shares outstanding and options outstanding for an additional 3,333,333 shares.
A) Which P/ E (trailing or forward) should Stewart use to compare the two companies’ valuation?
B) Which of the two stocks is relatively more attractive when valued on the basis of P/ Es (assuming that all other factors are approximately the same for both stocks)?
Explanation / Answer
a. Usually analysts use leading P/E when the forecasted earnings are available. RUF also had unusual items that resulted in a lower EPS in the past. Hence the forward P/E should be used for the purpose of comparison.
b. Using forward EPS,
P/E of RUF = Price/ EPS
= 22.5/ (30000000/33333333)
= 25
P/E of HS = 44/ 2.2
= 20
HS is the more attractive stock