Just read through this part, I have a few things not so clear. 1) One of the rationales for the use of P/B ratio is listed as: “Book value has also been used in valuation of companies that are not expected to continue as a going concern”. What does “going concern” mean? Does it mean the company is going bankrupt or out of business? What would be an intuitive example for this P/B advantage? 2) Regarding the advantages and drawbacks discussion of P/S The first rational is “Sales are generally less subject to distortion or manipulation…etc.” The last listed drawback is “Although relatively robust with respect to manipulation, revenue recognition practices offer the potential to distort P/S.” These sound a bit contradicting because the possibility still exists for P/S distortion. That’s why I chose the answer A when I worked at the Vol. 5 p. 229 #17 although the answer sheet says it’s C. Also both P/E and P/B are more susceptible to acc./mngt distortion/manipulation? Thx.
it means what it says pretty much. investors need to be careful with p/s b/c a company can use aggressive sales tactics to boost thier sales. If stock is flat and sales go up, the PE gets smaller, making the stock look cheap a good analyst will back out suspicious sales and arrive at a better p/s for P/b – going concern mneas the analyst expects the company to last forever, pretty much. when you model out cash flows, that is why you have a terminal growth rate – you expect the co to be around forever and think FCF or dividends will grow in perpetuity. this is all explain VERY well in the book. if you are using stalla, I recommend going back to the original material
meant to say that the PS gets smaller – not PE sorry, i am dumb tired and still slamming beer after beer
hyang, i just memorised all four
level1_dec Wrote: ------------------------------------------------------- > hyang, > > i just memorised all four Yes, I memorized all four too. But I still think understanding each scenario is more important than just memorize. Sometimes memory does not always stick. Thx, daj224. That said, what would be the issues of using P/B as valuation IF the company is a going concern???
for going concern, one would not be using P/B as much as another more practical ratio like P/S or P/E I know this sounds dumb, but try not to OVER analyze everything . for the multiples section in the EQUITY book, just focus on what is in the book… There are four major multiples and the book clearly talks about the pros and cons of each
hyang, i have compared advantages and disadvantages mentioned in schwser and book are same for all 4 price ratios.
P/BV * Comparison with firms of different size, different countries is misleading. Chk out R&D expensing * Inflation and technology change is not factored into the BV ,which makes the ratio an inaccurate measure of shareholders investment * Does not recognize value of human capital and other non physical assets.
Thanks, guys. Yes, I think I did over-think the stated words… So when use P/B, the company is not expected to be a going concern. My trouble was and still is how do you accurately judge whether an average company is a “going concern” or not? It’s sort of ambiguous word here: it could be going eternal/perpetual or going dead/bankrupt? which direction?
you dont know if a company will be a going concern forever, if you did, youwould short it and be a billionaire. all it is saying that as soon as a company gets distressed and may not be around ina year, investors will scrub the books and look at p/book ratios. the book tends to be mostly hard assets and that is what can be sscapped and sold for cash in a liquidation analysis. this is in the book, i think.
hyang Wrote: ------------------------------------------------------- > Thanks, guys. Yes, I think I did over-think the > stated words… > > So when use P/B, the company is not expected to be > a going concern. My trouble was and still is how > do you accurately judge whether an average company > is a “going concern” or not? It’s sort of > ambiguous word here: it could be going > eternal/perpetual or going dead/bankrupt? which > direction? Hyang: If I understand what you’re saying, I think you’re overstating things just a bit. I think the takeaway is not that you only use P/B when the company is NOT a going concern. It’s just that this measure is particularly relevent in that situation. In a going concern framework, value comes from both assets in place and future growth opportunities (the first is proxied for by book value, and the second is far more captured by the P/E ratio). In a case where the company is not going concern, value is more determined by assets in place (i.e. book value), since future earnings are not an issue. In reality, the multiples (P/E, P/B, P/S, P/CF) are usually pretty highly (although not perfectly) correlated. It’s just that they have unique weaknesses (and that’s one of the reasons why they’re not perfectly correlated).
busprof Wrote: > > In a going concern framework, value > comes from both assets in place and future growth > opportunities (the first is proxied for by book > value, and the second is far more captured by the > P/E ratio). In a case where the company is not > going concern, value is more determined by assets > in place (i.e. book value), since future earnings > are not an issue. > Thx. This explanation sounds reasonable. The book mentioned P/B is more suitable for companies whose assests are largely composed of liquid assets such as banks, insurance companies etc. As we know now, the fate of many regional banks especially some community banks is very uncertain. So we can say there are potential “going concern” for these companies, right? Thus despite they are the type of companies that fit the criteria, however, under this particular circumstance, we should not use P/B for their valuations.