CFA Level I · CFA Level I Exam · Relative Value Equity Valuation Approaches
An analyst is valuing a mature, profitable company with positive and stable earnings. Compared with using price-to-sales, the analyst's primary reason for preferring the price-to-earnings multiple is most likely that earnings:
The best reason is that earnings are the primary focus of investors and drive value. P/E is popular because earnings power determines investment value. Earnings are still affected by accounting choices and can be negative, so the other statements are incorrect.
- Aare immune to differences in accounting choices.
- Bare the primary focus of investors and drive value.Correct
- Care never negative for listed companies.
Explanation
P/E is widely used because earnings power is the primary determinant of investment value and P/E is closely linked to stock returns. Earnings are affected by accounting choices and can be negative, so the other two statements are wrong.
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