The following were the PE ratios of firms in the aerospace/defense industry at the end of December 1993, with additional data on expected growth and risk.

a. Estimate the average and median PE ratios. What, if anything, would these averages tell you?

b. An analyst concludes that Thiokol is undervalued, because its PE ratio is lower than the industry average. Under what conditions is this statement true? Would you agree with it here?

c. Using a regression, control for differences across firms on risk, growth, and payout. Specify how you would use this regression to spot under- and overvalued stocks. What are the limitations of this approach?

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Expected Company PE Ratio Growth Beta Payout Boeing 17.3 3.5% 1.10 28% General Dynamics 15.5 11.5% 1.25 40% General Motors-Hughes 16.5 13.0% 0.85 41% Grumman 11.4 10.5% 0.80 37% Lockheed Corporation 10.2 9.5% 0.85 37% Logicon 12.4 14.0% 0.85 11% Loral Corporation 13.3 16.5% 0.75 23% Martin Marietta 11.0 8.0% 0.85 22% McDonnell Douglas 22.6 13.0% 1.15 37% Northrop 9.5 9.0% 1.05 47% Raytheon 12.1 9.5% 0.75 28% Rockwell 13.9 11.5% 1.00 38% Thiokol 8.7 5.5% 0.95 15% United Industrial 10.4 4.5% 0.70 50%