Institute of Chartered Financial Analysts of India (ICFAI) University 2006 Certification Finance Security Analysis-II - Question Paper

Details
Company A
Company B
Company C

Sales
Rs.100
Rs.100
Rs.100

Gross Profit
Rs.40
Rs.40
Rs.40

Operating Income
Rs.15
Rs.15
Rs.15

Interest Expenses
0
Rs.15
Rs.40

Pretax Income
Rs.15
0
(Rs.25)

Taxes
Rs.5
0
(Rs.8)

Net Income
Rs.10
9
(Rs.17)

Total Assets
Rs.200
Rs.200
Rs.200

Net Debt
0
Rs.150
Rs.400

presumed Market Capitalization
Rs.300
Rs.150
Rs.10

Price to Sales Ratio
3.0
1.5
0.1


Even though all of the companies are in the identical boat operationally, the Price to Sales Ratio indicates that companies B and C are truly cheaper than company A. In fact, the Price to Sales Ratio points to company C as the cheapest of the bunch, even though it is the 1 that appears headed towards bankruptcy. Thus, this indicates that higher amounts of debt truly tend to skew the Price to Sales Ratio lower, sometimes significantly.

A better tool to use is the so-called "enterprise value-to-sales" ratio, or EVSR. A company's enterprise value is the company's market capitalization plus debt minus cash. Think of enterprise value as the buyout price 1 would have to pay to buy all the stock, retire all the debt, and then use the leftover cash to offset the cost. By comparing enterprise value instead of market capitalization to sales, at lowest we can take a company's capital structure into consideration.

Finally, the Price to Sales Ratio is not only useless in many cases, but it can also sometimes be a contrary indicator of a company's evaluation. This is why it is important to look at several ratios as a group to get a sense of a company's cash-flow generating capacity and the price the investors have to pay to get proportionate share of that cash flow.
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5.


Net benefits table by active trading

No.
Month
Signal
Price

(Rs.)
Transaction cost (Rs.)
Net price

(Rs.)
Net gain (Rs.)

1
Apr-May
Buy
118
0.59
118.59


2
Jun-July
Sell
136
1.02
134.98
16.39

3
July-Aug
Buy
132
0.66
132.66


4
July-Aug
Sell
132
0.98
131.01
-1.65

5
July-Aug
Buy
131
0.66
131.66


6
July-Aug
Sell
131
0.99
131.02
-1.64

7
July-Aug
Buy
131

Earning:   Approval pending.