The following is true about the price earnings ratio
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A. B. C. D.Explanation
PE ratio is calculated based on expected earnings per share and a ratio of less than 5 to 8 makes a stock appear underpriced.
The correct answer is A. The price-earnings ratio (P/E ratio) is the ratio between the company's current market value and its earnings per share.
The price-earnings ratio is a widely used financial metric that helps investors assess the relative value of a company's stock. It is calculated by dividing the market price per share of a company's stock by its earnings per share (EPS). The EPS is typically derived from the company's most recent financial statements, such as the income statement, which reports the company's net income.
The P/E ratio is often interpreted as an indicator of market sentiment towards a stock. A high P/E ratio suggests that investors are willing to pay a premium for each dollar of earnings, indicating expectations of strong future growth. Conversely, a low P/E ratio may indicate that the stock is undervalued or that there are concerns about the company's future prospects.
Answer B, "none of these answers," is incorrect because there is a correct answer among the given options.
Answer C, "the ratio is calculated based on the earnings per share from the past year," is not accurate. While it is common to use the most recent earnings per share, the P/E ratio can also be calculated using estimated future earnings or using an average of past earnings. However, the most common practice is to use the most recent earnings.
Answer D, "stocks with price-earnings ratios of 25 or less are considered to be underpriced," is not true. The perception of whether a stock is underpriced or overpriced based on the P/E ratio depends on various factors, including the industry, market conditions, and growth prospects. A P/E ratio of 25 or less may indicate that the stock is relatively cheaper compared to stocks with higher P/E ratios, but it does not necessarily mean it is underpriced. The interpretation of the P/E ratio should be done in conjunction with other fundamental and qualitative analysis.
Therefore, the correct answer is A. It is important to note that this explanation is based on general knowledge and may not precisely reflect the specific context of the CFA Level 1 exam or the particular question from the provider "Test Prep." It is always recommended to refer to the official study materials and guidelines provided by the CFA Institute for accurate and up-to-date information.