CFA Level I · CFA Level I Exam · Relative Value Equity Valuation Approaches
An analyst values an early-stage software company that has negative earnings and is investing heavily in growth. Which multiple is most likely to be the most appropriate for comparing it with peers?
Price to sales is the most appropriate multiple. The company has negative earnings, so P/E is meaningless, while sales are positive and less distorted by discretionary growth spending. Firms like this usually pay no dividends, so dividend-based measures are unusable.
- APrice to salesCorrect
- BPrice to earnings
- CEnterprise value to dividends
Explanation
With negative earnings, P/E is meaningless. Sales are positive and less affected by accounting choices and discretionary spending, so P/S is usable. Dividends are typically nonexistent for such firms, and EV to dividends is not a standard multiple.
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