Reading 44: Market-Based Valuation: Price and Enterprise Val following, 2011, possible, valuation, including

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Session 12: Equity Investments: Valuation Models
Reading 44: Market-Based Valuation: Price and Enterprise Value Multiples

LOS c: Discuss rationales for and possible drawbacks to using price multiples (including P/E, P/B, P/S, P/CF) and dividend yield in valuation.

 

 

Which of the following is a disadvantage of using price-to-sales (P/S) multiples in stock valuations?

A) The use of P/S multiples can miss problems associated with cost control.

B) It is difficult to capture the effects of changes in pricing policies using P/S ratios.

C) P/S multiples are more volatile than price-to-earnings (P/E) multiples.

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Due to the stability of using sales relative to earnings in the P/S multiple, an analyst may miss problems of troubled firms concerning its cost control. P/S multiples are actually less volatile than P/E ratios, which is an advantage in using the P/S multiple. Also, P/S ratios provide a useful framework for evaluating effects of pricing changes on firm value.

[此贴子已经被作者于2011-3-21 11:31:35编辑过]

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An argument against using the price-to-earnings (P/E) valuation approach is that:

A) earnings can be negative.

B) research shows that P/E differences are significantly related to long-run average stock returns.

C) earnings power is the primary determinant of investment value.

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Negative earnings render the P/E ratio useless. Both remaining factors increase the usefulness of the P/E approach.

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Analyst Ariel Cunningham likes using the price/earnings ratio for valuation purposes because studies have shown it is very effective at identifying undervalued stocks. However, she has one main problem with the statistic – it doesn’t work when a company loses money. So Cunningham is considering switching to a different core valuation metric. Given Cunningham’s rationale for using the price/earnings ratio, which option would be her best alternative?

A) Price/book.

B) Price/cash flow.

C) Price/sales.

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Book value is usually positive, but not always. Cash flow is often negative. If the reason Cunningham wants to stop using the P/E ratio is that it does not work for unprofitable companies, her best option is a ratio base on sales, which are positive in all but the rarest of instances.

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Bill Whelan and Chad Delft are arguing about the relative merits of valuation metrics.

Whelan: “My ratio is less volatile than most, and it works particularly well when I look at stocks in cyclical industries.”

Delft: “The problem with your ratio is that it doesn’t reflect differences in the cost structures of companies in different industries. I like to use a metric that strips out all the fluff that distorts true company performance.”

Whelan: “People can’t even agree how to calculate your ratio.”

Which valuation metric do the analysts most likely prefer?

Whelan

Delft

A) Price/book EV/EBITDA

B) Price/cash flow Price/book

C) Price/sales Price/cash flow

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The price/sales ratio is not very volatile, and it is of particular value when dealing with cyclical companies. The price/cash flow ratio considers the stock price relative to cash flows, ignoring the noncash gains and losses that can skew earnings. A major weakness of the price/cash flow ratio is the fact that there are different ways of calculating it, making comparisons difficult at times.

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An analyst focusing mostly on financial stocks is likely to prefer valuing stocks via the:

A) price/sales ratio.

B) price/book ratio.

C) dividend yield.

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The price/book ratio is a preferred tool for valuing financial stocks.

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An argument for using the price-to-earnings (P/E) valuation approach is that:

A) research shows that P/E differences are significantly related to long-run average stock returns.

B) earnings volatility facilitates interpretation.

C) earnings can be negative.

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Research shows that P/E differences are significantly related to long-run average stock returns. Both remaining factors reduce the usefulness of the P/E approach.

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An argument for using the price-to-earnings (P/E) valuation approach is that:

A) earnings can be negative.

B) management discretion increases the reliability of the ratio.

C) earnings power is the primary determinant of investment value.

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Earnings power is the primary determinant of investment value. Both remaining factors reduce the usefulness of the P/E approach.

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A firm is better valued using the discounted cash flow approach than the P/E multiples approach when:

A) expected growth rate is very high.

B) dividend payout is low.

C) earnings per share are negative.

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P/E multiples are not meaningful when the earnings per share are negative. While this problem can be partially offset by using normalized or average earnings per share, the problem cannot be eliminated.

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Barnes is contemplating the use of a price/earnings ratio to value a start-up medical technology firm. Which of the following is the most compelling reason not to use the P/E ratio?

A) P/E ratios for medical-technology firms with different specialties are not comparable.

B) Earnings per share are not a good determinant of investment value for medical-technology companies.

C) The company is likely to be unprofitable.

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Earnings are the chief determinant of value for most companies, including med-tech. P/E is the most common valuation method and the best known by lay investors. Comparability of P/E ratios across industries is always problematic, but not as much so for within the med-tech industry. A start-up company is very likely to have negative earnings, which renders the P/E ratio useless. (Study Session 12, LOS 44.c)

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Based on their responses to Powell, which of the analysts is most likely concerned about earnings volatility?

A) Lincoln.

B) Bosley.

C) Barnes.

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Book value tends to be more stable than earnings. Therefore, Lincoln’s favorite valuation tool, the P/B ratio, is less volatile than the P/E. The P/S ratio tends to be less volatile than the P/E as well, but Bosley’s other favorite, earnings yield, is just as volatile. The method preferred by Barnes is likely to be more volatile than the P/B ratio. (Study Session 12, LOS 44.c)

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Based on their responses to Powell, which of the analysts has proposed a method that has the best chance to work for determining the relative value start-up companies?

A) Marks.

B) Bosley.

C) Lincoln.

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Start-up companies tend to be unprofitable, and also often have negative free cash flow. Book value has some predictive power for such companies, but this is also often negative for new and unprofitable companies. The price/sales ratio, one of Bosley’s favorites, is the only metric that will work even if earnings, cash flows, and book value are negative. (Study Session 12, LOS 44.c)

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Barnes would be least likely to use EV/EBITDA ratio, rather than the P/E ratio, when analyzing a company that:

A) reports a lot of depreciation expense.

B) has a different capital structure than most of its peers.

C) pays a dividend, and is likely to deliver little earnings growth.

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For companies that report a lot of depreciation expense or must be compared to companies with different levels of financial leverage, the EV/EBITDA ratio may be more useful than the P/E. For companies that pay a dividend and have little profit growth, both should work fine. Given Barnes’ stated preference for the P/E ratio, she is least likely to use the EV/EBITDA ratio with the dividend-paying firm. (Study Session 12, LOS 44.c)

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Barnes is considering the four methods previously described to analyze the small-cap stocks provided to her by Powell. For which method does Barnes provide the weakest justification?

A) The price/sales ratio.

B) The PEG ratio.

C) The mean P/E of S& 500 companies.

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No valuation method will work dependably across all types of stocks. The four Barnes proposed are probably as good as any. But the PEG ratio does not correct for risk – it works as a comparison tool only if the companies have similar expected risks and returns. The other justifications are reasonable. (Study Session 12, LOS 44.c)

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Which of the following is a disadvantage of using the price-to-book value (PBV) ratio?

A) Book values are affected by accounting standards, which may vary across firms and countries.

B) Book value may not mean much for manufacturing firms with significant fixed costs.

C) Firms with negative earnings cannot be evaluated with the PBV ratios.

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The disadvantages of using PBV ratios are:

1. Book values are affected by accounting standards, which may vary across firms and countries.
2. Book value may not mean much for service firms without significant fixed costs.
3. Book value of equity can be made negative by a series of negative earnings, which limits the usefulness of the variable.