got asked this in an interview today.
Suppose Company A and Company B have the same income statement down to operating profit, operate in the same industry, and everything else is essentially the same (balance sheet, statement of cash flows, etc). However, Company A has a P/E ratio of twice that of Company B. Why might that be the case?
Just curious.
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Some intangible reason, maybe everybody thinks that company B has shitty management, their biz plan is shit, they just got sued, their drug patent got shot down, etc; something that affects the "feeling" about the company enough to make it trade at a lower P/E than A
Growth prospects for the companies might be drastically different.
If cashflow statements are identical, that rules out one having higher interest expense than the other. Also rules out one having some type of tax shield or advantage.
Yeah I guess growth is the only tangible reason I can think of off the top of my head
What drives multiples are growth and returns (usually measured by ROIC or some RO_ metric). Even though they may have had the same results and same balance sheet, if expectations of future returns and future growth are lower for company B (for one of the reasons olafenizer expressed, like bad management, bad business plan, etc.) the co. is going to trade at a lower multiple.
The answer they were fishing for is that the two companies probably have different capital structures.
The reason that equity multiples are such a bad idea is because when a company has debt, equity value does not grow linearly with net income growth. Equity value actually grows faster than net income. So you wouldn't want to try and calculate equity value as a multiple of net income, because it would give you incorrect results.
Confidence in the management
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