Supervisor's Statements on Price Multiples

Explanation

Let's evaluate each statement provided by the supervisor and determine which one is least likely to be correct.

Statement 1: P/S ratios are not able to capture the different cost structures of companies. The price-to-sales (P/S) ratio compares a company's stock price to its revenue per share. This ratio is commonly used to assess a company's valuation relative to its sales. The supervisor argues that P/S ratios are unable to capture the different cost structures of companies. However, this statement is likely incorrect. While P/S ratios do not directly account for cost structures, they provide a useful measure of market expectations regarding a company's revenue generation. Investors often consider P/S ratios alongside other financial metrics to gain insights into a company's valuation.

Statement 2: The P/CF ratio is more stable than the P/E ratio. The price-to-cash flow (P/CF) ratio compares a company's stock price to its cash flow per share. It is a valuation metric used to evaluate a company's ability to generate cash flow. The supervisor suggests that the P/CF ratio is more stable than the price-to-earnings (P/E) ratio. This statement is generally correct. Cash flows are less subject to manipulation and accounting adjustments compared to earnings, which can be influenced by various accounting practices. Therefore, the P/CF ratio tends to be less volatile and more stable than the P/E ratio.

Statement 3: An advantage of the P/B ratio (unlike the P/E ratio) is that the P/B ratio cannot be negative. The price-to-book (P/B) ratio compares a company's stock price to its book value per share. It is a valuation metric used to assess whether a stock is overvalued or undervalued relative to its accounting book value. The supervisor claims that an advantage of the P/B ratio, unlike the P/E ratio, is that it cannot be negative. This statement is correct. The P/B ratio compares the market price of a stock (which cannot be negative) to its book value (which also cannot be negative), ensuring that the P/B ratio itself cannot be negative. In contrast, the P/E ratio can be negative if a company reports negative earnings.

Based on the analysis, the statement that is least likely to be correct is:

A. Statement 1: P/S ratios are not able to capture the different cost structures of companies.

While each statement should be carefully evaluated, statement 1 is least likely to be correct because P/S ratios are indeed able to provide insights into a company's valuation relative to its sales, even though they may not directly account for cost structures.