CFA CFA Level 2 FRA – Integration of Financial Statement Analysis Techniques (Reading 24 p403) – EOC Q19

FRA – Integration of Financial Statement Analysis Techniques (Reading 24 p403) – EOC Q19

  • This topic has 4 replies, 3 voices, and was last updated Apr-17 by bceagles.
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    • Alta12
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      Can someone please explain the workings for the P/E ratio. Thanks.

    • Alta12
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      Why are we using net income in the denominator?

    • Zee Tan
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      I’m not sure what your question is @alta12… I mean, why not?

      P/E ratio is one of the measures to determine if a company is worth investing in. The P/E ratio comes from the rationale of ‘well, let’s see how great this company is at generating money for its shareholders’.

      If you use revenue, you’re not taking into account it’s COGS. If you use EBITDA, you’re not taking into account tax and depreciation effects. So net income seems like a fair measure (i.e. funds available either as dividends or reinvestment).

      Hope that helps!

    • Alta12
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      @zee I would have used earnings before tax given in the table. Not accurate because of pre tax?

    • bceagles
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      @Alta, just as you have to pay taxes to the government (a real expense) so too does a corporation so investors use P/E as a metric because they are interested in understanding how much the market is willing to pay for each dollar of earnings (an earnings multiple).

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