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Stocks 402: Using Ratios and Multiples

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1.
The price/book ratio would be most useful for valuing which of the following?
Choose wisely. There is only one correct answer.
A utility company. The price/book ratio is most useful for valuing a utility company. A utility firm has mostly tangible assets that are accurately measured by its book value. On the other hand, a pharmaceutical or software company has a lot of intangible assets, such as patents, that are not accurately reflected in its book value.
2.
One advantage of earnings yields over price/earnings ratios is that we can use them to compare investments in other classes.
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True. This way, we can compare the returns that the different types of investments offer.
3.
An advantage to using the price/sales ratio is that sales are cut-and-dried.
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True. Sales are more straightforward and harder to manipulate than earnings.
4.
In a nutshell, the price/earnings growth ratio of a company provides a quick and easy way to estimate the price you're paying for _______.
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Its future growth. This is because the ratio uses future estimates. Many investors want to know what a company's prospects will be.
5.
A company has an enterprise value of $225 million, free cash flow of $15 million, and zero net interest expense. What is its cash return?
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6.7%. Cash return is equal to free cash flow divided by enterprise value. In this case, that's $15 million/$225 million, or 6.7%.
6.
Company Z pays an annual dividend of $2.00 per share, and its stock trades for $25. What is its dividend yield?
Choose wisely. There is only one correct answer.
8%. The dividend yield is found by dividing annual dividend per share by stock price per share. Therefore, 2/25 equals 8%.
7.
A company's price/earnings ratio is most meaningful when it is compared with which of the following?
Choose wisely. There is only one correct answer.
Its historical P/E ratio. A company's P/E ratio is most meaningful when it is compared with its historical P/E ratio. The most useful way to use a P/E ratio is to compare it with a certain benchmark. Good benchmarks are the P/E of another company in the same industry, the P/E of the entire market, or the P/E of the same company at a different point in time. It would not be very meaningful to compare a company's P/E ratio with its P/S ratio or historical P/B ratio, because the latter two metrics are used to measure different aspects of the company's performance (sales and book value) relative to its stock price.