Question

Relative Valuation Methods with Price Multiples:

1. Price-to-Sales Ratio
2. Price-to-Cash Flow Ratio
3. Price-to-Book Ratio

What are the benefits and disadvantages of these methods?

Would you ever use any of them as stand alone valuation methods of a target company?

Answer 1

Price to sales:

Advantages:

1. One can calculate for distressed firm because sales can't be negative.

2. Sales revenue not easily manipulated.

3. useful for mature, cyclical and startup firm since it sales value is always there.

Disadvantages:

1. high sales doesn't imply high cashflow or profit.

2. use of revenue distortion technique can manipulate sales figure.

3. Does not capture cost structure difference.

Price to cash flow ratio:

Advantages:

1. difficult to manipulate cashflow.

2. Mitigate earning quality concerns.

3. More stable ratio than price to earning.

Disadvantages:

1. more volatile ratio to calculate.

2. difficult to estimate true CFO

Price to book ratio:

1. book value almost always greater than 0.

2. More stable than Earning per share.

3. It measure net asset value of financial institutions.

Disadvantages:

1. book value is not equal to market value

2. it can be manipulated by accounting choices

3. size difference causes misleading comparisons between two companies.

I would like to use all of these methods for valuation of target company rather than one , because in that way I can minimize the biases of these methods and reach the correct valuation.