Question 3 (20 points) A. Why might a firm trade at a price-to-book ratio (P/B)

Question

Question 3 (20 points) A. Why might a firm trade at a price-to-book ratio (P/B) greater than 1.0 B. If the price-to book value per share is less than one, what does that mean? C. A stock may trade below its book value for several reasons. List some of these factors D. Pick a company from Saudi Stock Market that its stocks has been traded below its book value. Name this company? Why it was traded below its book value? Are stocks trading below their book value a good bet? Explain? E. If a firm is expected to have a profit margin of 8 percent but trades at a price-to sales ratio of 25, what inferences would you make? F. Should a firm that has higher free cash flows have a higher value?

Explanation / Answer

Answer:

A.There might be a positive intrinsic market premium

B.If the price to book value per share is less than 1 , it indicates that the stock is undervalued.

C.Factors stock may trade below its book value for following reasons :

1.When market doesnt trust the books.2.The value of assets are dropping substantially.3.The company is adopting aggressive accounting policies to bloat its net worth.

E.A multiple of 25 is high for a P/S ratio and is an extremely high price to sales ratio if only 8% of each dollar of sales ends up in earnings.

P/E = P/S ;S/E = 25 / 0.08 = 312.50 which is extremely high.Stock is overvalued.

F.Price to cash flow ratio defines that lower a stock,s Pric/cashflow ratio the better value that stock is .

Example:Market value is $25 for both A and B .A has cash flow of 5 and B has 10.In this case Price/cashflow A = 25 / 5 = 5 ; B = 25 / 10 = 2.5 Lower the ratio better the value ..therefore higher the cashflow better the value.

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