Price Multiples Flashcards
(17 cards)
When should you use the Dividend Discount Model (DDM) vs. Price Multiples?
Use DDM when valuing mature, dividend-paying firms with stable dividends. Use price multiples for broader comparisons, especially when dividends are irregular or absent.
What are some rationales for using the Price-to-Earnings (P/E) ratio?
P/E is widely used, linked to earnings (value drivers), and tied to stock returns.
What are key drawbacks of the P/E ratio?
Can be distorted by low or negative earnings, earnings manipulation, and differences between permanent vs. transitory income.
Why is a long-term perspective important in investing?
It helps manage crises calmly, improves asset allocation, avoids market timing errors, and enables recovery from short-term losses.
What is risk aversion in utility theory?
Risk-averse investors prefer a certain return over a risky one with the same expected return. Utility functions reflect diminishing marginal utility of wealth.
What is a key pricing trait of growth stocks?
They have high prices relative to profits, resulting in a high P/E ratio.
What type of businesses are typical of growth stocks?
Disruptive technologies or firms with ambitious business expansions and high growth expectations.
What are the risks and rewards associated with growth stocks?
They are highly volatile but offer potential for large capital gains.
What are common features of value stock companies?
Stable business models, low share price volatility, and often pay regular dividends.
What is a key pricing trait of value stocks?
They trade at a low price relative to profits, leading to a low P/E ratio.
How does the upside potential of value stocks compare to growth stocks?
Value stocks may have limited capital gain potential but offer steady income.
What is the PEG ratio and why is it important?
PEG = Price-to-Earnings / Growth rate. A PEG < 1 is considered desirable, indicating a stock is undervalued relative to its growth.
When is EV/EBITDA useful?
Comparing firms with different leverage or capital structures.
Enterprise Value formula?
MarketCap+Debt−Cash
When is the P/S (Price-to-Sales) ratio most useful?
It’s helpful for valuing firms in cyclical industries or companies with volatile or negative earnings, since sales are less affected by economic cycles.
Why is FCF a preferred metric for some analysts?
It provides insight into operating efficiency and sustainability, and is a strong predictor of long-term stock performance.
Which valuation metric is most appropriate for start-ups or early-stage companies?
P/S (Price-to-Sales) is most useful because start-ups often have no earnings or cash flow, but generate revenue.
