Happy hump day all. Wanted to share an interesting article from Forbes (thanks Dad for sharing). The author spends the article evaluating based on their Price to Earnings (P/E) ratios.
Quick refresh, a P/E ratio is the price of the stock (i.e. a share of Apple costs $544 today) divided by the annual earnings (net income) of the stock. In theory a low P/E ratio means you get more “bang for your buck” because you get more earnings for less cost. It’s a way of valuing stocks on a relative basis, since you can’t just compare stock prices.
He provides some examples of stocks that are still cheap in the market based on their P/E ratios. His standout is Apple, which trades at 14 times earnings. The $12,000 comment is that if Apple had the same multiple as Netflix (300) it would be a $12,000 stock (i.e. $544 x 300).
I want to add on to his article though. While a P/E ratio is a good thing to check when investing, it should in no way be the only thing you test (which his article kind of implies). Stocks can have high P/E multiples and still be valuable. If investors believe the stock has a lot of growth potential the P/E ratio will be a lot higher, because price is being compared to future, not current earnings. If you’re looking fora growth stock, P/Es above 100 are not uncommon at all.
That being said, when a stock’s s P/E multiples just defy every law of common sense, i.e. Twitter, I avoid them no matter how much growth investors think they have. Twitter should not be trading at twice the multiple of Facebook, when Twitter makes NEGATIVE money right now.
Finally, I leave you with the author’s fantastic Forbes picture. This cartoon treatment is legit.