Page 6 - FINAL CFA II SLIDES JUNE 2019 DAY 8

LOS 31.b: Calculate and interpret a justified price multiple. READING 31: MARKET-BASED VALUATION: PRICE AND
LOS 31.c: Describe rationales for and possible drawbacks ENTERPRISE VALUE MULTIPLES
to using alternative price multiples and dividend yield in
valuation. MODULE 31.2: P/B MULTIPLE
LOS 31.d: Calculate and interpret alternative price multiples
and dividend yield.

P/B Ratio – Advantages:
• A cumulative amount that is usually positive, even when the firm reports a loss and EPS is negative.
• More stable than EPS, so it may be more useful than P/E when EPS is particularly high, low, or volatile.
• It is appropriate measure of NAV for firms that primarily hold liquid assets. Examples include insurance, and banking firms.
• P/B can be useful in valuing companies that are expected to go out of business.
• Empirical research shows that P/Bs help explain differences in long-run average stock returns.

P/B Ratio – Disadvantages:
• P/Bs do not reflect the value of intangible economic assets, such as human capital.
• P/Bs can be misleading when there are significant differences in the asset size of the firms due to the business model
(outsourcing production can lower book value, and increase P/B ratio).
• Different accounting conventions can obscure the true investment in the firm made by shareholders, which reduces the
comparability of P/Bs across firms and countries. For example, research and development costs (R&D) are expensed in
the United States, which can understate investment.
• Inflation and technological change can cause the book and market values of assets to differ significantly, so BV is not an
accurate measure of the value of shareholders’ investment. This makes it more difficult to compare P/Bs across firms.