PE, PB, PS and EV/EBITDA are four very popular financial ratios that business ma
ID: 2761456 • Letter: P
Question
PE, PB, PS and EV/EBITDA are four very popular financial ratios that business managers use. In each of the following situations, which one of the 4 ratios will be most appropriate to use for comparing stock values? (assuming you only have information about current/trailing ratios) A company is highly levered (i.e., has a lot of debt). However, its peer group has low leverage. (PE, PB, PS, or EV/EBITDA) You suspect that the company engages in manipulation of its expenses (by recognizing too little expenses in the current year) (PE, PB, PS, or EV/EBITDA) You find the subject company has a high possibility of bankruptcy. You want to compare the company with other company's in the same Industry AND in financial distress (PE, PB, PS, or EV/EBITDA) The subject company is healthy non-manipulator. Moreover, its earning is stable, positive and NOT subject to cyclical effect (PE, PB, PS, or EV/EBITDA)Explanation / Answer
a As there is diffference of leverage, I shall use EV/EBITDA ratio that will nullify the effect of interest on debt and the ratio will be comparable for firms having different leverage. b As there is problem with expense reporting of the firm, I shall use PS (Price to Sales ) ratio to avoid the effect of expenses c I shall Use PB (Market Price to Book Value ) ratio as this ratio will be lower than 1 only in case of firms having Financial distress and bankruptcy risks. Sp PB ratio is the most useful for such firms. d As the subject company is healthy without much fluctuation is earnings and without cyclical effects, P/E ratio is the ideal one to compare performance.
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