F ILE A research analyst is trying to determine whether a firm's price-earnings (P/E) and price-sales (P/S) ratios can explain the firm's stock performance over the past year. A P/E ratio is calculated as a firm's share price compared to the income or profit earned by the firm per share. Generally, a high P/E ratio suggests that investors are expecting higher earnings growth in the future compared to companies with a lower P/E ratio. The P/S ratio is calculated by dividing a firm's share price by the firm's revenue per share for the trailing 12 months. In short, investors can use the P/S ratio to determine how much they are paying for a dollar of the firm's sales rather than a dollar of its earnings (P/E ratio).

In general, the lower the P/S ratio, the more attractive the investment.The accompanying table shows the year-to-date

(YTD) returns and the P/E and P/S ratios for a portion of the 30 firms included in the Dow Jones Industrial Average. The complete data set can be found on the text website, labeled Dow 2010.

YTD return

(in %) P/E ratio P/S ratio 1 .3M Co. 4.4 14.37 2.41 2. Alcoa Inc. − 4.5 11.0 1 0.78 30. Walt Disney Company 16.3 13.94 1.94 SOURCE: The 2010 returns (January 1, 2010-December 31, 2010) were obtained from The Wall Street Journal, January 3 , 2010; the P/E ratios and the P/S ratios were obtained from finance.yahoo.com on January 20, 2011.

a. Estimate: Return = β 0 + β 1 P/E + β2 P/S + ε . Are the signs on the coefficients as expected? Explain.

b. Interpret th e slop e coefficient o f the P /S ratio.

c. What is the predicted return for a firm with a P/E ratio of 10 and a P /S ratio of 2?

d. What is th e standard error of the estimate? Calculate and interpret

e. In te rp re t R2.