Comprehensive problem - Part 3
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b) The Price Earnings Ratio is a performance indicator that shows the market’s confidence in a particular organization. The higher the ratio the greater the assurance of investors that profits will grow strong in the nearby future. Indeed the ratios calculate above complement such preposition. During 1998 and 2000 the price earnings ratio increased in line with higher profitability and rising diluted earnings per share.
However in 2001 a drop of 50% arose in the firm’s profits adversely affecting the shareholder’s return from investment leading to a decreasing confidence in the corporation.
b) A drastic decrease in the price to book ratio, like what happened in 2001, may indicate that there is something wrong with the company. Indeed when one looks at the financial statements of 2001 one can see decreasing profitability.
Randall H - Comprehensive problem introduction. (1999). A Level Accounting. Third Edition. Great Britain: Ashford Colour Press Ltd.