Question #73
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: 27
Status: Unattempted
Correct Answer: B
Question
A common justification for using earnings yields in valuation is that:
Answer Choices:
A. earnings are more stable than dividends
B. negative earnings render P/E ratios meaningless and prices are never negative
C. earnings are usually greater than free cash flows
Explanation
g = r −[
]
g = 0.14 −[
]
g = 5.88%
B0 × (ROE−r)
V0−B0
14.38 × (0.20−0.14)
25−14.38
Negative earnings render P/E ratios meaningless. In such cases, it is common to use
normalized earnings per share (EPS) and/or restate the ratio as the earnings yield or E/P
because price is never negative. Price to earnings (P/E) ranking can then proceed as usual.