Financial Ratio Analysis Limitations
Although Financial Ratio Analysis has limitations, it is a great tool to find the problematic areas in the company so that managers can go back and address the problems. One of the limitations is differences in accounting standards around the world that can distort financial ratios. Select two publicly traded US companies listed on the NASDAQ stock market and calculate each company’s P/E (Price to Earnings Ratio) and MB (Market to Book Ratio). What do these ratios tell you about how investors value these two companies’ future prospects? *Make sure your selected companies are different than your classmates’.
Search the SEU library or the Internet for an academic or industry-related article. Select an article that relates to these concepts and explain how it relates to doing business in Saudi Arabia. For your discussion post, your first step is to summarize the article in two paragraphs, describing what you think are the most important points made by the authors (remember to use citations where appropriate).
For the second step, include the reference listing with a hyperlink to the article. Do not copy the article into your post and limit your summary to two paragraphs. Let your instructor know if you have any questions and enjoy your search.
Financial practitioners and economists have sought to examine the metrics that can be used in predicting market stock returns in the past few decades. They have assessed different variables as future determinants of stock performance (Aras & Yilmaz, 2008). Besides, they have found DY (dividend yield), P/E (price-earnings ratio), market-to-book ratio (MtB), beta, and the interest rate to be somewhat reliable indicators, among other measures. Intuitively, MtB, DY, and P/E ratio could be classified as multiples that markets attach to earnings, dividends, and book values. In determining earnings and market prices, dividends and book values could be useful for predicting behavior of stock returns and prices in the future. Thus, one can use dividends and book values to develop profitable strategies for trading. Aras and Yilmaz (2008) have quoted the mispricing model, which postulates that stocks with high E/P or low P/E ratios tend to earn higher returns compared with stocks with low E/P or high P/E ratios. Therefore, portfolio returns and P/E ratios are inversely related. Investors could obtain systematically higher returns by investing in stocks with low P/E ratios.According to Aras and Yilmaz (2008), securities with high market ratios between their market and their equity or book values persistently generate lower returns compared with low MtB ratio securities. The DY, MtB, and the P/E share several common features. One of these traits is that they can be used to measure stock prices based on particular fundamentals. Regarding the prediction of stock returns, some researchers found P/E or MtB to be significant, while others found DY to be substantial. However, in their analysis, Aras and Yilmaz (2008) revealed that investors in the developing markets could use the MtB ratio to predict the possible market stock returns for one year with a high level of certainty. They also found that P/E, in contrast, does not play a significant role in predicting stock returns. However, combining the two variables with the DY may enhance the effectiveness of the assessment. Investors can also enhance the effectiveness of their assessments by adding some variables like the CPI (consumer price index).
References
Aras, G., & Yilmaz, M. K. (2008). Price-earnings ratio, dividend yield, and market-to-book ratio to predict return on stock market: Evidence from the emerging markets. Journal of Global Business and Technology, 4(1), 18-30.