When I was five years old, my father – a salesman at a spice company – taught me five things. He taught me how to play Gin Rummy, keep score at a baseball game, read a box score from a baseball game, pour a vodka soda and lime (three parts club soda, two parts vodka), and how to read a stock ticker in the Baltimore Sun’s Business section. What do all of these things have in common? They all require a strong understanding of division – a necessity for comprehending a P/E ratio.
They also were the things that allowed a five-year-old to constructively hang out with the sales team of the world’s largest spice firm. I was bartending at parties for company executives by Christmas.
No joke. I can’t make that up. I’m a failed fiction writer.
I quickly learned the spice trade and its value in buying by the pound and selling by the ounce. I learned the difference between inelastic demand and elastic demand and why pepper brands were price sensitive by sale was not. But I also – like clockwork – always knew what the price of McCormick stock was. I’d open the paper each morning and tell my father how his investment (and career, I suppose) was doing.
I look back on those moments today because those business sections listed a lot of numbers. It’d note McCormick’s stock price, it’s daily high, it’s daily low, its 52-week high, its 52-week low, and it’s…
Price-to-Earnings (P/E) Ratio
Today, it feels like the P/E ratio doesn’t mean much to investors anymore. This metric tells you how many years it would take to generate your return on investment based on the current stock price and the company’s earnings.
Here’s how crazy this market is. Based on Tesla’s earnings, it would take more than 661 years to justify the price. Of course, P/E ratio doesn’t exactly dictate stock price when the world is in a frenzy to pour money into the market as speculators.
But P/E ratio is still VERY important. I want to take a second and explain why you need to care about P/E ratio when you’re analyzing stocks.
Right now, fundamentals in the market are largely out the window. The Fed and the government’s pumping of trillions of dollars has tilted the market. But we’re going to see a return to basics. We’re going to see people analyzing balance sheets and metrics like P/E and see how they compare to their peers.
Take a look at Home Depot (NYSE:HD) . Its stock trades at a P/E Ratio of 28.1. Its rival Lowe’s (NYSE:LOW) trades at a P/E ratio of 26. They don’t really do anything different. But one might check the box for Lowe’s just looking at this simple metric. It’s not an endorsement. It’s just a single, simple thing to keep in mind while doing research or analyzing two company’s side-by-side.
Or, if we want to do the automobile example again, Tesla (NASDAQ:TSLA) has a P/E ratio north of 660. Meanwhile, Volkswagen (OTC:VWAGY) trades at just 15.7. That’s comparatively pretty cheap for a company that is poised to overtake its rival Tesla in Electric Vehicle sales in the next three years.
I’ll be back with some more insight on a MAJOR U.S. trend that threatens our supply chains.