"Equity Investments": Financial Analysis Techniques

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Questions 1:

A firm reports negative earnings for the year just ended. The price multiple of the firm’s stock that is least likely to be meaningful is:

A 、trailing price to earnings.

B、 price to cash flow.

C、 leading price to earnings.

Questions 2:

A fund manager compiles the following data on two companies:

Equity Investments: Financial Analysis Techniques

The best conclusion the fund manager can make is that Company A’s stock is more attractive than Company B’s stock because of its:

A 、smaller price-to-earnings ratio (P/E).

B、 greater financial leverage.

C、 higher dividend growth rate.

View answer resolution

【Answer to question 1】A

【analysis】

A is correct. Negative earnings in the last year result in a negative ratio of trailing price to earnings and are not meaningful. Practitioners may use the ratio of (1) current price to cash flow or (2) leading price to earnings by replacing last year’s loss with forecasted earnings.

B is incorrect. Alternative to negative trailing price-to-earnings ratio, practitioners may use price-to-cash-flow ratio because it is possible cash flow would be positive in spite of a small loss.

C is incorrect. Alternative to negative trailing price-to-earnings ratio, practitioners may use leading price-to-earnings ratio by replacing last year’s loss with forecasted earnings which may be positive.

【Answer to question 2】A

【analysis】

A is correct. From the following computations, Company A’s stock is more attractive than Company B’s stock because of its smaller P/E.

Equity Investments: Financial Analysis Techniques