![]() ![]() (2) Reliance on accounting data requires numerous and significant adjustments. : (1) The models rely on accounting data that can be manipulated by management. (5) The models focus on economic profitability rather than just on accounting profitability (4) The models are applicable even when cash flows are volatile. (3) The models are applicable to firms that do not pay dividends or that do not have positive expected free cash flows in the short run. (2) They use accounting data, which is usually easy to find. (1) Terminal value does not dominate the intrinsic value estimate, as is the case with dividend discount and free cash flow valuation models. The following are the strengths and weaknesses of. (5) Empirical research finds that differences in ratios are significantly related to differences in long-run average stock returns. (3) While less subject to distortion, revenue recognition practices can still distort sales forecasts. (2) The ratio does not capture differences in cost structures across companies (1) High growth in the numerator does not necessarily indicate high operating profits (4) The ratios are particularly appropriate for valuing stocks in mature or cyclical industries and start-up companies with no record of earnings. (3) The ratio is not as volatile as P/E multiples (2) The denominator is not as easy to manipulate or distort (1) P/S is meaningful even for distressed firms, since the denominator is always positive. (4) Inflation and technological change can cause the book and market values of assets to differ significantly, so book value is not an accurate measure of the value of shareholders’ investment ![]() (3) Different accounting conventions can obscure the true investment in the firm made by shareholders, which reduces the comparability of the ratio across firms and countries (2) The ratio can be misleading when there are significant differences in the asset size of the firms under consideration because in some cases the firm’s business model dictates the size of its asset base ![]() (1) The ratio does do not reflect the value of intangible economic assets, such as human capital (5) Empirical research shows that the ratio help explain differences in long-run average stock returns. (4) The ratio can be useful in valuing companies that are expected to go out of business. (3) The denominator is an appropriate measure of net asset value for firms that primarily hold liquid assets. (2) The denominator is more stable than EPS, so it may be more useful than P/E when EPS is particularly high, low, or volatile. (1) The denominator is a cumulative amount that is usually positive, even when the firm reports a loss and EPS is negative. (6) If the analyst expects deferred tax liabilities to continue to increase (i.e., not reverse), increases in deferred tax liabilities should be to/from net income Increases in deferred tax assets that are not expected to reverse should be. to/from net income, and the accretion of the bond premium should be. (5) For a bond issuer, the amortization of a bond discount should be. ![]() (4) Income from restructuring charge reversals and other noncash gains should be. are also removed (they would be accounted for under fixed capital investment) to/from net income However, if the firm is accruing these costs to cover future cash outflows, then the. (2) Provisions for restructuring charges and other noncash losses should be. to/from net income, much like depreciation. Some examples of noncash charges that often appear on the cash flow statement: (1) Amortization of intangibles should be. ![]()
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