Over the past couple of days, the global stock markets seem to have turned-up from the dismal decline of the first two and-a-half weeks of the year. Today in fact, the Dow Jones Industrial Average closed up by 211 points and NASDAQ, which has been beaten-down even more, was up by 110 points. Perhaps it is a little early, however, to assume that stocks are out of their stupor yet; but, we can certainly hope so.
Last Friday, a doctor that I often discuss the financial markets with, told me that his broker has been suggesting that he buy some stock in Amazon. That brings me to the Stocks and Groceries analogy. Over the past year, Amazon (AMZN) and Netflix (NFLX) have doubled in price. Does that mean that they are good buys now? Remember that brokers make money when clients buy or sell; but, not when cash just sits idle on the sidelines.
Many investors, like my doctor, do not have a clue as to what a good price for a stock is. Consider, however, when whoever does the grocery shopping in your family goes to the market, they generally have an idea as to what a pound of beef or pork should be, and similarly for: a gallon of milk; a dozen eggs; a head of lettuce; toothpaste; cereal; etc. Well, we have a similar measure for stocks: it’s called the “P/E Ratio”.
The P/E, or price-to-earnings ratio, is what an investor might pay for the earnings per share of a particular stock. That’s just like the price per pound, ounce, gallon, etc. at the market. The most common benchmark is the P/E for the Standard and Poor’s 500 Index of large company stocks, which currently runs around 15.73X—meaning that an investor would be paying $15.73 for each $1.00 of those corporations’ earnings per share.
Now, there is nothing sacrosanct about the S&P’s P/E. Some stocks are growing faster and deserve to trade at a higher “multiple”, as the P/E is often referred to. And other companies, generally more mature and slower-growing, might trade at a lower P/E. But, what about AMZN and NFLX?
Amazon closed today at $596.38 per share, with a P/E of 864.32 times earnings. I believe that it is important to note, however, that Amazon’s Earnings per Share, over the past five years has been: $1.79 (estimated) in 2015; and continuing on at -0.52; +0.59; -0.09 and +1.37 through that span. And Netflix closed today at $100.72, for a P/E of 354.65 times earnings. The NFLX per share earnings over the past five years was: $0.28 est. in 2015; 0.62; 0.26; 0.04 and 0.61.
Among the analysts who cover these two companies 84.5 % rank AMZN either a “Strong Buy” or a “Buy” (out of five rankings) and 63% rank NFLX in those top two categories. So, brokers who might recommend buying these stocks do have some credibility. But, how does that compare to the price for the S&P 500—or a pound of ground beef? Also consider the fact that Wall Street analysts rarely assign “Sell” ratings.
Consider how technologies have changed, and oftentimes with even newer trends replacing the last “Big Thing”? Societies’ likes and dislikes are also quite whimsical, and subject to change, as well. So, is it really worth it to pay $864.32 or even $354.65 for the stock of relatively new companies when just $15.73 will buy the average of tried and true large companies?