Question #6

Reading: Reading 22 Market-Based Valuation - Price and Enterprise Value Multiples

PDF File: Reading 22 Market-Based Valuation - Price and Enterprise Value Multiples.pdf

Page: 3

Status: Incorrect

Correct Answer: A

Your Answer: B

Part of Context Group: Q6-8 First in Group
Shared Context
- Which of the following explanations is least likely to explain why Jenkins' stock picks underperform? A) Large stocks have an outsized effect on the benchmark data. B) She is using the mean rather than the median valuation as a benchmark. C) Many stocks in the benchmark group are mispriced.
Question
Which valuation ratio is least appropriate for comparing Massive and Mouse?
Answer Choices:
A. Enterprise value/EBITDA because Massive and Mouse have very different debt levels
B. Price/book because Massive is larger than Mouse
C. Price/cash flow because cash flows for small companies can be extremely volatile
Explanation
The P/B ratios can be misleading when used to compare companies with vastly different asset bases. A large semiconductor company is likely to have lots of fixed assets, while a tiny software company may have very few assets. The P/CF ratio tends to be more stable than the P/E ratio. The P/E ratio is useless for considering companies that lose money, but that does not mean the measure has no value when earnings are positive. The EV/EBITDA ratio is effective at comparing stocks with different degrees of financial leverage.
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