A firm may use a price-sales ratio instead of a price-earnings ratio when it has had (negative/positive) earnings over the past year. Which is correct?

• A. Stable earnings
• B. Negative earnings
• C. Zero earnings
• D. Positive earnings

Answer: (B)

Verified step by step guidance

1. Understand the definitions: The price-earnings (P/E) ratio is calculated as \(\frac{\text{Price per Share}}{\text{Earnings per Share}}\), and it requires positive earnings to be meaningful.
2. Recognize that if a firm has negative earnings, the P/E ratio becomes negative or undefined, which makes it unreliable for valuation purposes.
3. Learn that in cases of negative earnings, analysts often use the price-sales (P/S) ratio instead, which is \(\frac{\text{Price per Share}}{\text{Sales per Share}}\), because sales are usually positive even when earnings are negative.
4. Conclude that the firm would use a price-sales ratio when it has had negative earnings over the past year, as the P/E ratio would not provide useful information.
5. Therefore, the correct choice is 'Negative earnings' because stable, zero, or positive earnings allow the use of the P/E ratio, but negative earnings do not.