Question #91
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: 32
Status: Unattempted
Question
Analyst Ariel Cunningham likes using the price/earnings ratio for valuation purposes because studies have shown it is very effective at identifying undervalued stocks. However, she has one main problem with the statistic – it doesn't work when a company loses money. So Cunningham is considering switching to a different core valuation metric. Given Cunningham's rationale for using the price/earnings ratio, which option would be her best alternative?
Answer Choices:
A. Price/sales
B. Price/cash flow
C. Price/book
Explanation
Book value is usually positive, but not always. Cash flow is often negative. If the reason
Cunningham wants to stop using the P/E ratio is that it does not work for unprofitable
companies, her best option is a ratio base on sales, which are positive in all but the rarest
of instances.