NISM Certifications · NISM-Series-XV: Research Analyst · Valuation Principles
Which of the following is a recognised limitation of the P/E ratio as a valuation tool?
A key limitation of P/E is that it becomes not meaningful when earnings are negative or very small. Since the denominator is earnings per share, loss-making companies cannot be valued with it, and accounting differences and one-off items can also distort it.
- AIt cannot be used when earnings are negative, as the ratio becomes not meaningfulCorrect
- BIt ignores the market price of the share
- CIt can only be applied to banks
- DIt always gives the same value across accounting policies
Explanation
P/E divides price by earnings, so negative or near-zero earnings make it meaningless. It uses market price, applies to all sectors, and is affected by differing accounting policies and one-off items.
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