1. ©2012 McGraw-Hill Ryerson Limited 1 of 34 Learning Objectives 4.Calculate the yields on financial claims based on the relationship between current price and future expected cash flows. (LO4) 5.Describe the use of a price-earnings ratio to determine value. (LO5)

2. ©2012 McGraw-Hill Ryerson Limited 2 of 34 Valuation Using the Price-Earnings Ratio The Price-Earnings (P/E) ratio can also be used to value stocks The P/E ratio is influenced by: – the earnings and sales growth of the firm – the risk (or volatility in performance) – the debt-equity structure of the firm – the dividend policy – the quality of management – a number of other factors In May 2011, the average P/E for the top 300 companies of the Toronto Stock Exchange was 20 to 1. LO5

3. ©2012 McGraw-Hill Ryerson Limited 3 of 34 High versus Low P/Es A stock with a high P/E ratio: – indicates positive expectations for the future of the company – means the stock is more expensive relative to earnings – typically represents a successful and fast-growing company – is called a growth stock A stock with a low P/E ratio: – indicates negative expectations for the future of the company – may suggest that the stock is a better value or buy – is called a value stock LO5