Discuss the relationship between growth stocks and income stocks and their P/E ratios
What will be an ideal response?
Answer: A growth stock is a company that is actively growing and expanding. This growth requires a lot of capital so they seldom pay much in dividends, if any. Instead they plow their earnings back into the growth of the company. A fast growing company leads to the potential for fast growing earnings per share. When the market thinks this growth company has good earnings growth, they bid the share price up accordingly representing higher P/E ratios.
Most income stocks are from companies who are relatively large and mature in their industries. Since they are not in an active growth mode, then they don't need to retain earnings and can instead pay them out to the shareholders in the form of high dividends. Because they are not expected to have a lot of growth in earnings, then the market does not bid up their market price resulting in relatively low P/E ratios.
You might also like to view...
When an item of revenue is collected and recorded in advance, it is normally called a(n) ___________ revenue.
a. accrued b. prepaid c. unearned d. cash
Which of the following describes the term "passage of risk"?
A. the period given to the seller to rectify nonconforming goods B. a period during shipment when neither buyer nor seller bears the risk of loss C. the period during which the seller is responsible for losses to the goods D. the point in time when the buyer becomes responsible for losses to the goods