CFA Practice Question

There are 201 practice questions for this study session.

CFA Practice Question

Which of the following statements is the LEAST accurate with respect to the drawbacks of using the price to sales (P/S) ratio for valuation purpose?
A. The P/S ratio may lead to misleading results if the underlying company is experiencing a period of abnormal sales growth.
B. While the P/S ratio will always be positive, ultimately the valuation of the company should be based on its earnings generation capacity.
C. Sales do not take into account the degree of operating and financial leverage employed by the company; however, valuation does.
Explanation: As is the case with price multiples, the price in the ratio is assumed to have incorporated all relevant data. In other words, if a company is experiencing a period of abnormal growth, the multiple would simply reveal this and the investor can make a decision accordingly.

User Contributed Comments 3

User Comment
RNAN The price is the factor that is assumed to always be accurate (due to lots of smart investors trading wisely and rebalancing mispricings). The sales part of the ratio can swing around widely and make the ratio uncomparable.
wollogo No what they mean is that if there is abnormal growth then the price would increase with sales meaning little change in the P/S ratio.
bbadger What they mean is that if a company is experiencing abnormal sales growth, the price of the stock will be abnormally high to compensate. If the growth is thought to be abnormal, no way will that be true. It'll trade at a low P/S and not be mispriced. I'd argue in a relative ratio sense it would be misleading.
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