Question #63
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: 22
Status: Correct
Correct Answer: B
Question
Which of the following is a disadvantage of using price-to-sales (P/S) multiples in stock valuations?
Answer Choices:
A. It is difficult to capture the effects of changes in pricing policies using P/S ratios
B. The use of P/S multiples can miss problems associated with cost control
C. P/S multiples are more volatile than price-to-earnings (P/E) multiples
Explanation
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.