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Basic Question 4 of 7
The following statements are rationales to use P/E for equity valuation except for ______.
II. Differences in P/Es are empirically related to differences in long-run average returns.
III. P/E is more stable than P/BV since historical cost-based approach of GAAP leads to depressed asset value.
IV. P/E is often employed for valuation of cyclical, unprofitable and mature companies.
I. Earnings are the chief driver of investment value.
II. Differences in P/Es are empirically related to differences in long-run average returns.
III. P/E is more stable than P/BV since historical cost-based approach of GAAP leads to depressed asset value.
IV. P/E is often employed for valuation of cyclical, unprofitable and mature companies.
User Contributed Comments 3
| User | Comment |
|---|---|
| Rotigga | III. P/E is definitely not more stable then P/BV since earnings fluctuate more than BV IV. P/E cannot be used for unprofitable companies. E/P can be used, however. |
| prabhur08 | I'm not sure about III. Price should go up when earnings go up (and down when earnings come down). On the other hand, book value stays constant but price can go up or down! So P/E should be relatively more stable than P/BV. Agreed earnings fluctuate more than book value but we are talking P/E and P/BV and not earnings and book value in isolation. |
| davidt876 | wrong again prabhur. BV goes up or down with retained earnings (and therefore indirectly earnings). make a loss and your BV goes down - as well as your price. just think about the fact that P/E can vary exponentially up to infinity. Say a stock's price is $10, and EPS is normally $1. P/E = 10. But this year the economy squeezes the firm' profits and EPS falls to $0.01. Now P/E = 1,000. Now if you ever find a stock with a P/B of 1,000... run.. |
I used your notes and passed ... highly recommended!
Lauren
Learning Outcome Statements
calculate and interpret alternative price multiples and dividend yield;
calculate and interpret underlying earnings, explain methods of normalizing earnings per share (EPS), and calculate normalized EPS;
explain and justify the use of earnings yield (E/P);
describe fundamental factors that influence alternative price multiples and dividend yield;
calculate and interpret the justified price-to-earnings ratio (P/E), price-to-book ratio (P/B), and price-to-sales ratio (P/S) for a stock, based on forecasted fundamentals;
calculate and interpret a predicted P/E, given a cross-sectional regression on fundamentals, and explain limitations to the cross-sectional regression methodology;
evaluate a stock by the method of comparables and explain the importance of fundamentals in using the method of comparables;
calculate and interpret the P/E-to-growth ratio (PEG) and explain its use in relative valuation;
calculate and explain the use of price multiples in determining terminal value in a multistage discounted cash flow (DCF) model;
explain alternative definitions of cash flow used in price and enterprise value (EV) multiples and describe limitations of each definition;
calculate and interpret EV multiples and evaluate the use of EV/EBITDA;
CFA® 2025 Level II Curriculum, Volume 4, Module 23.