To determine the value of each stock (the nail), we cannot use one valuation method (the Hammer). Different industries have different characteristics. It is like judging the ability of a fish to climb a tree by using the same ruler to measure their performance.
The P/E ratio
One of the most popular Wall Street valuation methods is the price/earnings ratio. The term is often used by Bloomberg and CNBC news anchors. They use it to quickly determine whether a stock’s price is too high or low.
The P/E ratio is a measure of a company’s share prices relative to its earnings power. If a company’s share price is $100 and it generates $5 per share, then that would give us a 20 P/E ratio. Investors will pay $20 per dollar for the company’s earnings. Investors will pay more for every dollar of earnings if the ratio is higher.
A stock’s high P/E does not necessarily mean it is highly valued. If you buy a stock at $100, and the company doubles its earnings from $5 to $10 per share, the P/E calculated based on your cost price drops to 10. It now feels like we got a great deal because of the company’s growth.
A low P/E multiple doesn’t necessarily mean a bargain. The P/E calculated on your cost price will now be 40 if the company’s earnings fall by 50% to $2.50. We suddenly realize we have a problem and must get rid of it.
The future growth of a stock will determine whether its P/E multiple is high or low. We will all be successful long-term if we don’t overpay growth.
The ratio P/CF
Companies with consistent earnings are the best candidates for the P/E ratio. However, if the P/E ratio were applied to growth companies with inconsistent earnings you might have missed amazing stocks such as Amazon.
Amazon’s historic P/E ratio is unbeatable. The company has traded at a P/E close to 4,000 in the past and has an average ratio of 267.7. It’s not possible that I would pay $267.70 per dollar of earnings.
Amazon’s high P/E results are due to Amazon constantly investing its profits in future growth . Amazon had a net profit of less than US$1billion in 2016 – that was just once.
Amazon’s cashflow is a different story. Its operating cash flow grew at 31.8% compounded annual growth from US$1.4 million in 2007 to US$38.5 trillion in 2019.
Where should you invest?
You might consider investing your money in more lucrative types of investments. You can invest in unit trusts, fixed deposits or the stock market. If you still want to invest in gold, but not in gold jewellery, then do so. It is better to invest in solid gold, such as bullion (gold bar) or gold coins.
Apart from that, you should look into the best ways to invest gold such as through gold investments accounts. You can invest in Malaysia through CIMB Gold Investment Account or Kuwait Finance House Gold Account (i), and Maybank Gold Investment Account.