Firms with higher expected growth rates tend to have P/E ratios that are Higher than the P/E ratios of firms with lower expected growth rates. Correct answer: letter B.
Investors are willing to pay higher prices for stocks of companies with high expected growth rates, as they are confident that the stock price will increase in the future. This higher demand for the stock of these companies drives up the price, thus making the P/E ratio higher. On the other hand, investors tend to be more conservative and less willing to pay higher prices for stocks of companies with lower expected growth rates, thus leading to lower P/E ratios.
Growth rates vary from company to company but generally speaking, the growth rate of a company is a measure of the rate of increase of the company’s revenues or profits over a period of time. Generally, high-growth companies tend to have higher growth rates than low-growth companies.
A company’s growth rate can also be compared against the industry average or the “market” average. Growth rates can be measured on a quarterly, yearly, or multi-year basis.
Firms with higher expected growth rates tend to have P/E ratios that are ___________ the P/E ratios of firms with lower expected growth rates.
A) Lower than
B) Higher than
C) Equal to
D) There is not necessarily any linkage between risk and P/E ratios.
Learn more about the growth rates of companies:
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