Question 3 20 points A Why might a firm trade at a pricetobo

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?

Solution

Part 1 - Price to book ratio is the ratio of Market price of company\'s share over its book value of equity (i.e. Assets - Liabilities)

Firm trade at Price to book ratio greater than 1.0 because it means that Stocks are overvalued and Company is functioning well and company is earning positive return on assets

Part 2 - If Price to Book ratio is less than 1.0.

It says two things when Price to boom ratio is less than 1.0

1) Stock is undervalued

2) Company is earning poor/negative return on assets or company is not functioning well

Part 3 - There are various Factors when stock may trade below its book value. Such Factors are:-

a) There is lack of confidenc in investors towards company

b) There are other outdated tangible assets on balance sheet which adds to book value

c) Company has acquired several businessess with less synergy resulting into creating huge goodwill on asset side which has not market value

d) Company is delivering poor financial performance resulting into negative return on assets

e) Various accounting policies used by companies to boast the net worth which practically has no market value

Part 4 - Kingdom Holding Company. The company traded below book price because of the exceptionally poor performance and almost decline of 15% in earnings resulting into loss of SR 31 Billion.

Hence looking at the scenario, Any stock trading at less than Market price is not a good bet.