If you are interested and new to investing in shares, it can be confusing what to look for when making a first assessment about the price of a stock. But there are some easy key metrics that can give you a quick overview of where a stock is ‘at’ and how its price compares to its peers (similar companies) and if now is a good time to buy or not.
When visiting the websites of the various stock exchanges, each stock listed on that exchange will have information about its share price today and graphs of its historical share price as well information regarding its market capitalisation and its multiples. But what does that even mean?
Market Capitalisation
The first thing to look at is market capitalisation. ‘Market cap’, in financial lingo, is the total number of publicly traded shares of a company multiplied by its share price. Some companies have a large market cap; this can be an indication of the companies’ strength, perceived value or both. Tesla, for example, has a market cap of $886 billion and car maker BMW a market cap of €59.6 billion. Clearly, investors seem to value Tesla more (in fact 11x more adjusted for currency) than BMW, although BMW does sell many more cars than Tesla.
Multiples
Traders, investors and financial commentators use the word ‘multiples’ constantly. But what are these multiples and what do they say about the price of a stock? The most used multiples are the Price/Earnings ratio (P/E) and the Price/Sales ratio (P/S).
Multiple 1: P/E
P/E, the price-earnings ratio, is the price of a stock divided by its earnings per share (EPS). The company’s net earnings are what is left over after all the costs have been deducted from its total revenues. The remaining earnings are then divided by the number of shares that are publicly traded, resulting in the earning per 1 single share, the EPS.
Take our favourite phone maker Apple for example (market cap $2.73 trillion), its EPS for2021 is $5.67 and its (P) price per share is $168. So, the P/E is ($168/$5.67) = 29.06. Or the other way around, you can find out the EPS by dividing the share price by the P/E ratio. Simple.
| $168/EPS of $5.57 | = | P/E of 29.62 |
| $168/PE of 29.62 | = | EPS of $5.67 |
Multiple 2: P/E
P/S: the Price to Sales ratio, in contrast to the P/E ratio, is the price of the share divided by the total annualised sales made by the company in the most recent reporting period. Sticking to the example of Apple, in order to calculate Apple’s P/S ratio, you first divide the company’s total 2021 sales of $378.35 billion by the total number of shares listed on the exchange, 16.32 billion shares in Apple’s case, giving you the Sales per Share. You then divide the stock price (P) by the Sales per Share to get the P/S multiple.
| $378.35 bln/16.32 bln | = | $23.18 per share |
| $168/ $23.18 | = | P/S of of 7.24 |
Multiples are used as a benchmark to compare stock prices. It will give a good idea if a stock is well priced or not. Low multiples may indicate good value but could equally indicate that a stock is not ‘hot’ as its financial outlook (future revenues) does not excite investors.
Putting multiples to the test: comparing Tesla to BMW
Coming back to the earlier comparison of Tesla and BMW, their market caps are vastly different, but how do their multiples compare? BMW makes more cars and makes more money than Tesla. Tesla’s P/E is 170.32 and its P/S is 17.98. BMW – in contrast - has a P/E of 5.12 and a P/S of 0.56. Given that BMW also makes electric cars, do these multiples makes sense and which company would you invest in? Which has the better relative price? If you believe Tesla will win the electric car race, your money maybe on Tesla. But BWM does look cheap in comparison and maybe the better buy?
Of course, marketcap, P/E and P/S ratios are not the only metrics to look at when investing, but they certainly make for a very good start. This type of information can easily be found on financial websites or on companies’ own websites to help you on your way.
And if you do like the idea of investing, (1) know your multiples; (2) check the income statements and balance sheets of each company/stock you think of investing in (also found on the websites) and (3) create a watchlist and paper-trade for a good while, taking in as much information as you can, before putting your money where your metrics are.
Suggested links:
https://www.talksforteens.com/finance/invest-the-warren-buffet-way-the-secret-of-compound-returns
https://corporatefinanceinstit...
https://www.forbes.com/advisor/investing/what-is-pe-price-earnings-ratio/
https://www.ft.com/content/41d016e5-9b46-4b80-8d40-4a0abbf7f6d6
https://money.cnn.com/2015/04/28/investing/millennial-investor-17-year-old-brandon-fleisher/
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