Final

Question 0

Price-to-cash-flow ratio

Answer 0

Earnings as reported on the income statement can be affected by the company’s choice of accounting practices and thus are commonly viewed as subject to some imprecision and even manipulation. In contract, cash flow - which tracks cash actually flowing into or out of the firm - is less affected by accounting decisions. As a result, some analysts prefer to use the ratio of price to cash flow when calculating this ratio; others prefer free cash flow, that is, operating cash flow net of new investment.

Question 1

Price-to-book ratio

Answer 1

This is the ratio of price per share divided by book value per share. Some analysts view book value as a useful measure of fundamental value and therefore treat the ratio of price to book value as an indicator of how aggressively the market values the firm.

Question 2

Proce-to-sales ratio

Answer 2

Many start-up firms have no earnings. As a result, the P/E ratio for these firms is meaningless. The price-to-sales ratio is sometimes taken as a valuation benchmark for these firms. Can vary markedly across industries, since profit margins vary widely.

Question 3

Weaknesses of P/E Analysis

Answer 3

• Too much leeway for choosing what to exclude in calculation.
• Ratios assume that earnings rise at a constant rate, where as they could fluctuate dramatically over the course of the business cycle.
• Must look at a company’s long-run growth prospects to determine if P/E is high or low.