05 Jul IDENTIFY AND BRIEFLY DISCUSS THREE REASONS WHY THE DISPARITY IN RATIOS MAY NOT INDICATE THAT…
CFA Examination Level III
Betty Black’s investment club wants to buy the stock of either NewSoft Inc. or Capital Corp. In this connection, Black has prepared the following table. You have been asked to help her interpret the data, based on your forecast for a healthy economy and a strong market over the next 12 months.
| NewSoft Inc. | Capital Corp. | S&P 500 Index | |
| Current price | $30 | $32 | n/a |
| Industry | Computer Software | Capital Goods | n/a |
| P/E ratio (current) | 25× | 14× | 16× |
| P/E ratio (5-yr avg) | 27× | 16× | 16× |
| P/B ratio (current) | 10× | 3× | 3× |
| P/B ratio (5-yr avg) | 12× | 4× | 2× |
| Beta | 1.5 | 1.1 | 1 |
| Dividend yield | 0.30% | 2.70% | 2.80% |
NewSoft’s shares have higher price/earnings (P/E) and price/book (P/B) ratios than those of Capital Corp. Identify and briefly discuss three reasons why the disparity in ratios may not indicate that NewSoft’s shares are overvalued relative to the shares of Capital Corp. Answer the question in terms of the two ratios, and assume that there have been no extraordinary events affecting either company.
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