Week 12 + Price multiples Flashcards
(15 cards)
What are the key tenets of Modern Portfolio Theory (MPT)?
Investors should hold diversified portfolios.
Only systematic risk affects asset prices.
Individual security risk matters less when held in a portfolio.
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 is the “Law of One Price” in valuation?
Similar assets should sell for similar prices — the basis for using comparables in market-based valuation.
Key strengths of P/E?
Widely used, linked to EPS (a core driver of value), related to returns.
Key weaknesses of P/E?
Can be distorted by transitory earnings, accounting choices, or negative/near-zero earnings.
P/B is best used for what types of firms?
Financial firms, liquidation scenarios, firms with positive book value.
Main drawbacks of P/B?
Book value may not reflect true asset values, especially for firms with lots of intangible assets (like tech or service companies).
Accounting methods vary, affecting comparability across firms.
Not useful for asset-light or growth companies, where market value is driven more by future earnings than book assets.
Key limitation of P/S?
Ignores profitability, does not reflect cost differences, can be misleading due to accounting principles.
Why use the P/S multiple?
Sales are always positive and harder to manipulate, making them useful for start-ups or distressed firms.
Why is P/CF often more reliable than P/E?
Cash flows are harder to manipulate than earnings and more stable.
Key drawback of P/CF?
FCFE frequently negative, cashs flows can become distorted
What does a high or low dividend yield indicate?
High yield may signal steady income or a falling stock price (potential risk).
Low yield is common in growth stocks that reinvest profits instead of paying dividends.
What are the main drawbacks of the EV/EBITDA multiple?
Ignores capital structure differences
Excludes working capital and capex
Can be manipulated through accounting choices in EBITDA
Not useful for firms with negative EBITDA
What are the main rationales for using the EV/EBITDA multiple?
It values a firm independent of capital structure, making it easier to compare companies with different debt levels.
It focuses on core operating performance, excluding non-operating items like interest and taxes.
It’s useful for capital-intensive industries, where depreciation skews net income but EBITDA smooths it out.
EV reflects the total value of the firm (debt + equity), aligning with EBITDA as a pre-financing cash flow measure.
