Question

What are some of the key weaknesses of ratios such as price-to-earnings, price-to-sales, and price-to-book value? How closely can they be relied upon to make investment decisions?

Answer 1

The use of ratios like Price to sales, Price to earnings and price to book value shows that how investors will use to act if the earnings and the use of assets of the company gets affected. But these ratios lacks the percentage of earnings of the company’s efforts like profit to sales ratios. These ratios also do not shows leverage effect / benefits to the investors, so the investment by the investors in the company will gets affected due to this.

The investment decisions are very much dependent on these ratios, so the price to sales / book value shows that how investors will react on temporary negative earnings of the company or if the company have a negative usage of the assets. It shows how investors are valuing the company ie. under or over-valuing the company based on the turnover or balance sheet position of the company.