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发表于 2012-3-31 15:02
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Analysts and portfolio managers at Big Picture Investments are having their weekly investment meeting. CEO Bob Powell, CFA, believes the firm’s portfolios are too heavily weighted toward growth stocks. “I expect value to make a comeback over the next 12 months. We need to get more value stocks in the Big Picture portfolios." Four of Powell’s analysts, all of whom hold the CFA charter, were at the meeting – Laura Barnes, Chester Lincoln, Zelda Marks, and Thaddeus Bosley. Powell suggested Big Picture should start selecting stocks with the lowest price-to-earnings (P/E) multiples. Here are the analysts’ comments:- Barnes said numerous academic studies have shown that low P/E stocks tend to outperform those with high P/Es. She uses the P/E ratio as the basis of most of her valuation analysis. “I prefer to use the justified P/E ratio because it is inversely related to the required rate of return.”
- Lincoln warned against using P/E ratios to evaluate technology stocks. He suggests using price-to-book (P/B) ratios instead, because they are useful for explaining long-term stock returns. “Book value is a good measure of value for companies with a lot of liquid assets, and it is easier to calculate than the P/E because you rarely have to adjust book value.”
- Bosley prefers the price/sales (P/S) ratio and the earnings yield. “The P/S ratio is particularly useful for valuing companies in cyclical industries because it isn’t affected by sharp changes in profitability caused by economic cycles.”
- Marks acknowledges that the P/E ratio is a useful valuation measurement. However, she prefers using the price/free-cash-flow ratio. “Free cash flow (FCF) is more difficult to manipulate than earnings, and it has proven value as a predictor of stock returns.”
Powell has provided Barnes with a group of small-cap stocks to analyze. The stocks come from a variety of different sectors and have widely different financial structures and growth profiles. She has been asked to determine which of these stocks represent attractive values. She is considering four possible methods for the job:- The PEG ratio, because it corrects for risk if the stocks have similar expected returns.
- Comparing P/E ratios to the average stock in the S&P 500 Index, because the benchmark should serve as a good proxy for the average small-cap stock valuation.
- Comparing P/E ratios to the median stock in the S&P 500 Index, because outliers can skew the average P/E upward.
- The P/S ratio, because it works well for companies in different stages of the business cycle.
Which analyst’s quote is least accurate?
Book value must be adjusted constantly, and it is generally more complicated to calculate than earnings. The other three statements are true. (Study Session 12, LOS 41.c)
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)
| The company is likely to be unprofitable. |
| B)
| P/E ratios for medical-technology firms with different specialties are not comparable. |
| C)
| Earnings per share are not a good determinant of investment value for medical-technology companies. |
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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 41.c)
Based on their responses to Powell, which of the analysts is most likely concerned about earnings volatility?
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 41.c)
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?
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 41.c, d)
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 41.c)
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 mean P/E of S&P 500 companies. |
| |
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 41.c) |
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