It’s easy for investors, particularly those who are new to investing, to think that a stock’s share price reflects the company’s underlying value. But this is not always the case.
You can have a stock price that has gone through the roof, but the company itself has never turned a profit. This has happened time and again, especially with tech companies. Remember the Dotcom Bubble of the late 1990s, and when that bubble burst in the early 2000s1. Today, Uber has a market cap of about US$95 billion, but it is not profitable.2,3
Why the disconnect? The share price only tells you what the market says it’s currently worth. That price is based on a number of factors, including industry and market trends, investor emotion, what’s happening domestically and globally and how that impacts consumer confidence in the economy, and what’s happening within the company itself.
A stock’s true value is what a company is actually worth in dollars and cents and at times can be difficult to determine. How you go about trying to figure out how to value a company is impacted by the sector it’s in and the metrics used. Price to earnings is a good starting point. I like to use a stock’s price to earnings to growth ratio. Fundamentally, if a company is growing top line earnings at 25% and its earnings multiples (stock price divided by earnings per share) are 15 times earnings, then you can argue its growth rate is higher than its valuation.
Metrics are just part of the equation. When determining a stock’s value, you also have to factor in the company’s market share, historical performance, future projections for earnings, sales over time, peers and competitors, and analysts’ reports.
All of this is what will help you determine if a stock is expensive or not. You have to look beyond the price and dig into the fundamentals that determine intrinsic value and compare this to where the stock trades today. Understanding the business, its profitability and potential for growth is what should guide your buying and selling decisions.
Call Me or Email Me
My approach to investing is straightforward. I study the markets, global economies and what’s happening within industries to be in a position to best help my clients find good quality investments that will help them meet their goals. I build custom portfolios for each client. I welcome you to call me at 416-332-3863 or email me at allan@allansmall.com.
References
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- Dotcom Bubble, Investopedia
- Uber Technologies, Inc. (UBER), Yahoo! Finance
- Will ride-hailing profits ever come? A detour into Uber and Lyft’s numbers, TechCrunch
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