You are right I think it should be accepted as an answer.
However, because this sentence can mean both, usually in spoken Hebrew we try to make a distinction between them. So if you want to say "The cat is Sarah's" you would rather say "החתול (הזה) הוא של שרה" or "החתול שייך לשרה" (the cat belongs to Sarah).
And The cat belongs to Sarah should really also be accepted surely. It seems to be splitting hairs to call it a mistake!
Because in Hebrew it'll be: החתול הוא של שרה. Its a whole sentence. But if i'll say: Sara's cat, I can continue. Sara's cat is sleeping. החתול של שרה ישן.
החתול שחור - the cat is black
If you can say החתול שחור to say that the cat is black, you can say החתול של שרה to say that the cat belongs to Sarah. If you can omit the הוא in the former, you can omit it in the latter.
So IMO it should be accepted. And yet, because of the potential ambiguity, most Israelis would not omit the הוא in this sentence, although they would in the other.