I am surprised there is not a consensus on this issue yet.
Topher did a good job explaining why ROE is correct in the third post, so I will lay out why the other options you guys have posted are wrong.
Keep in mind:
Return on Equity = (Net Income) / (Average Stockholder Equity) --- note average stockholder equity and book value are the same thing.
Price to Sales = Market Cap / Revenue
1. Positive ROE: Correct! Topher�s post explains why ROE is correct. Here are reasons why arguments against ROE are wrong:
tony2 Wrote:
-------------------------------------------------------
> when you screen though aren't you looking for
> companies to pop up in the screen, you could
> screen for P/BV but i think it just said book
> val.. so if you added book value to the screen
> woudln't you get negative book value returns as
> part of your screen whereas using CFO you'd get
> the companies with positive CFO
You would not get ANY companies that had negative book value, since you are screening FOR positive book value
GordGekko Wrote:
-------------------------------------------------------
> It has to be CFO. Book value can be misleading
> since it is often based on historical costs that
> are no longer relatavent to the firm's current
> situation and value. It's a stale number. CFO
> definitely screens for the ability of the company
> to continue operations in the future. Much more
> sound then BV.
This can be true, but you are making assumptions. More importantly, we are using ROE as a screen so if we thought book value was worthless we would not be using ROE in the first place!
2. Positive Cash Flow: Incorrect
whodey Wrote:
-------------------------------------------------------
> I went with Cash Flow. You can make a lot of $$$
> on your books but in the end that's just on paper
> and in reality cash is king. if you can't bring
> in cash from your operations you will either have
> borrow (higher risk for current sharehoulders),
> issue more stock (bad for current shareholders),
> or file chapter 7.
Nothing in this comment is incorrect. However, negative CFO is not an issue when screening for ROE and P/S as CFO is not included in either equation.
3. Positive P/E: Incorrect
This would be a possible answer since a positive P/E would mean the ROE number would not be misleading. However, this is only true for trailing P/E. Since forward P/E may be used, the screen may yield an incorrect ROE. Example: forward earnings are positive, so P/E is positive. However, trailing earnings and book value are negative, which would yield a misleading ROE number.
Therefore P/E is incorrect
4. Positive Sales Growth: Incorrect
krisC Wrote:
-------------------------------------------------------
> I answered positive sales growth. Simply because
> the P/S can be low if the price is low and the
> firm is doing badly. But if the sales growth is
> positive i.e. the firm is increasing its sales and
> still the market has undervalued it ( the price is
> low as compared to the others) then that is the
> stock that I am looking for !!!!! What do you guys
> think ????/
While the analysis that a company not experiencing revenue growth will likely have a lower P/S number is correct, the P/S number will still be correct (i.e. not meaningless). Also, the market is forward looking so screening past sales growth won�t necessarily help you get rid of companies that have low P/S because their prospects are poor.
Edited 1 time(s). Last edit at Thursday, June 12, 2008 at 06:44PM by Howd.