Never forget these two axioms:
Money frees us, but its pursuit enslaves us.
It’s not how much you have at the end; it’s how much you could have made.
Sorry for the delay recently, Once again, life got in the way, but back into it we shall go. We last left off talking about the PE ratio in its definition, how to interpret it, etc. Now that we did the theory work, let’s do the practical part (just like med school—Ugh).
Let’s keep using Microsoft (MSFT) as an example and then we can do some comparison shopping amongst the tech stocks.
Microsoft currently has a PE ratio of 51.01 with a stock price of 108.66. The current PE ratio of the S&P 500 is 22.60 (estimated as of 10/19/18) and was 24.97 on 1/1/18. (If you peruse the table at the other end of the link, you will see the PE ratio of the S&P 500 has steadily been rising since 2012—from 14.87 to over 20 today. This keeps cycling up and down as you can see in the table.
The highest PE ratio of late was the incredible 70.91 as of 1/1/09—as the market as a whole was sinking and wouldn’t find bottom for ten more weeks in mid-March. Everyone was focusing on how much stock prices were dropping, but earnings were plummeting even further thus making the PE ratio [remember that stock price is your numerator, but your denominator is the earnings—who know all that elementary school math would bubble back up in your adult life?] at the time spike up. You can then see as the market recovered the PE ratio fell back to normal human heights 20.7 by 1/1/10.)
So, what exactly does all this mean in terms of evaluating MSFT as a potential buy?
Comparing apples to apples (even if they are Red Delicious [a misnomer for sure] versus Gala—7,000!?! Wow. Who knew?), the MSFT PE ratio is 51.01 versus that of the S&P 500 (current estimation) of 22.60 meaning that MSFT is 2.257 times more “expensive” than the average stock in this market. Maybe that’s OK though. Purchasing is a matter of not only price, but value. You don’t get a 4,500 square foot house in the best neighborhood in town for the same price as a 1,200 square foot place in the sketchy part of the same town. We all buy the same things at very different prices and feel (are sure?) that we are getting a good value for the money we are parting with.
But, to compare with MSFT with the average stock in the market isn’t quite fair. If you’re car shopping and say that a Mercedes is far more expensive than a Kia, you’re absolutely correct and also stacking the deck in a ludicrous argument. You need to compare your Mercedes to other luxury vehicles (BMW, Audi, etc.—yeah, I like German cars). The same is true with stocks.
So, MSFT needs to be compared with the other well know multibillion technology stocks out there not the Proctor & Gambles and Coca-Colas of the world.
So, in terms of PE ratio (rounding to the nearest whole number), MSFT is 51, Facebook is 24, Amazon is 140, Apple is 20, Netflix (a technology company of sorts) is 119, and Google (never Alphabet in my view) is 47. These are the famous so-called FAANG stocks.
Sarcastic Reader: Hey fella, Apple at 20 and Facebook at 24 is way cheaper in terms of this PE ratio thing. Why not just buy one or both of them instead of Microsoft?
Dr. Scared: This is it! This is how they screw you!!!
PWT: Great point. Let’s compare MSFT vs Facebook vs Apple as far as if you have $10,000 and want to put it all on one stock all at once right now…next time.
Dr. Unwise: Damn it! This guy is getting good at the tease!
I’d love to hear from any and all of you about your thoughts, so we can all learn from one another.
Please spread the word about this blog to your friends (real and virtual), family, and colleagues. Talk to you soon.
Until next time…