Hi folks,
Here is the background info (“Swift is an analyst”):
The question is:
The correct answer is apparently (A). But why? If Sigma is just “now profitable”, isn’t there a high probability that it is not cash flow positive? And so using a P/CF ratio would not be feasible?
And why is using a P/S ratio not feasible in this case?
Thanks in advance.
Valuations are supposed to be forward-looking, not backwards-looking, so it really does not matter that the company only just became profitable. If you, as an analyst, do not think that they will be cash flow positive in the future, then this ratio will not work because you think that the recent move to profitability is unsustainable or is an outlier. However, the question says nothing about this.
The purpose of a multiple is so that the company you are valuing is comparable to its industry or peers. The Price-to-Sales ratio is typically based on net sales, not gross sales. Because Sigma pays a lower share of gross revenue to its independent contractors compared to its competitors, its net revenue will not be comparable to its peers. The net sales will be biased upwards compared to industry peers.
Thanks very much, @AKRapoza
But how do we know that the share of gross revenue paid to independent contractors is not considered under cost of sales (COS) instead?
Because if that were the case, wouldn’t the P/S ratio still be valid?
If that is what the company does, then yes I think it could still be valid.
It is hard to know for certain without more details. Does the specific question or vignette say anything about this?
