CFA Level I · CFA Level I Exam · Relative Value Equity Valuation Approaches
Price-to-sales is most likely preferred over price-to-earnings when the company being valued:
P/S is most useful when a company has volatile or temporarily negative earnings. Sales are less volatile than earnings and rarely negative, so the multiple remains meaningful when P/E is not. Revenue manipulation is a weakness of P/S, not an advantage.
- Ahas volatile or temporarily negative earnings.Correct
- Bhas stable margins and positive earnings.
- Creports revenue that is easily manipulated.
Explanation
Sales are less volatile and rarely negative, so P/S is meaningful when earnings are negative or erratic. A downside is that P/S ignores cost structure, and revenue recognition can be manipulated, which is a weakness not a reason to prefer it.
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