Page 13 - FINAL CFA II SLIDES JUNE 2019 DAY 8

Justified P/S READING 31: MARKET-BASED VALUATION: PRICE AND
Multiple ENTERPRISE VALUE MULTIPLES

Since net profit margin (PM ) o E /S , we can restate the GGM as: MODULE 31.4: EV AND OTHER ASPECTS
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Net profit margin (E /S ) thus influences P/S directly as well as indirectly
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through its effect on the sustainable growth rate, g:

Observations:
All else equal, the P/S ratio will increase, if:
• Profit margin increases.
• Earnings growth rate increases.

We can also do a little algebra and solve for P/S as a function of trailing P/E, which might be an easier formula to remember:

EXAMPLE: Calculating justified P/S ratio: A stock has a dividend payout ratio of 40%, a return on equity (ROE) of 8.3%, an
EPS of $4.25, sales per share of $218.75, and an expected growth rate in dividends and earnings of 5%. Shareholders require
a return of 10% on their investment. Calculate the justified P/S multiple based on these fundamentals.

Answer: E /S = $4.25 / $218.75 = 0.0194. Therefore,
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