Certified Valuation Analyst (CVA) Practice Exam

What can affect the pricing of a company's stock according to the P/E ratio?

1. Only the company's earnings

2. Market price fluctuations and earnings growth

3. Economic downturns only

4. Investor sentiment alone

The correct answer is: Market price fluctuations and earnings growth

The price-to-earnings (P/E) ratio is a significant financial metric that helps investors assess the value of a company's stock. It calculates the stock price relative to earnings per share, thus providing insight into what the market is willing to pay for a company's earnings. The correct answer involves the interaction of market price fluctuations and earnings growth because both elements are crucial in determining stock prices. Market price fluctuations can arise from various influences such as investor behavior, market conditions, and external economic factors, leading to changes in a company's stock price regardless of its earnings. On the other hand, earnings growth is a fundamental factor that investors look for; as a company's earnings increase, it generally justifies a higher stock price, potentially leading to an increase in the P/E ratio if the stock price remains stable. Considering earnings growth and market price fluctuations gives a more comprehensive view of what influences a stock's valuation according to the P/E ratio, as both these factors directly correlate with investor expectations and market dynamics.