mouse123

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.

mouse123

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

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

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

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

The disadvantages of using PBV ratios are:

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

mouse123

One advantage to using the price/book value (P/B) ratio over using the price/earnings (P/E) ratio is that P/B can be used when:

A) stock markets are volatile.

B) earnings or cash flows are negative.

C) the firm is in a slow growth phase.

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When earnings are negative, P/E ratios cannot be used but P/B ratios can be used. The firm's rate of growth and the volatility of markets do not suggest advantages of using P/B ratios rather than P/E ratios.