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  • Writer's pictureScott Richter

P/E stock trading

What makes a company – and its stock – valuable? At the end of the day, isn’t that what we’re all trying to assess here? If traders had it all figured out, we’d never lose any money, but as you know, that’s not the case. Fail though we sometimes do, it’s still in our best interests to consider a number of factors when predicting if a company’s stock will go up in value, and one of those crucial factors is P/E (profits and earnings), which is essentially the profitability of a company, and what multiple it trades at. In this blog post, we’ll examine some stocks that trade in a very risky P/E range, versus stocks that trade in a more comfortable P/E range, and what those things mean to investors.

Whether you’re new to trading, or a long-time veteran, this much is true: Be sure to research the companies you invest in, to make sure their valuations are on point. Whether you’re examining a company that’s been around for a while, or a new up-and-coming company, it would be wise for you to check that their valuations aren’t out-of-whack.

And when it comes to out-of-whack valuations, one example I like to use is Tesla: Believe it or not, they trade at a P/E of around 1,300! Yes, you read that correctly – that’s 1,300 times earnings. For example (and to keep the math simple), let’s say that Tesla’s real value (based on earnings) was one million dollars. Would you pay $1,300,000,000 to buy that company? Or, to put it differently, if the kid down the street only made one dollar selling lemonade, would you pay $1,300 to buy his lemonade stand? Needless to say, I think Tesla – a fine company overall – has a highly over-valued stock, and it’s going to bite some people if they’re not careful.

To put it in perspective, even most of the more aggressive stocks, like Apple, only trade at around 35 – 40 multiples, and if they increase in value, by say, doubling revenue in the next year or two, then that P/E obviously comes down to a better return on investment. But when you see companies that trade at a huge P/E level (COUGH, Tesla, COUGH), you have to be very careful, because if they ever miss their targets on earnings, or experience some other public negative event, then the value of those stocks can tank very quickly.

Another curve ball: When you’re looking at companies that pay large dividends (like oil and gas companies), they don’t trade at huge P/E multiples, because they aren’t really designed to keep a lot of cash on-hand – instead, they’re paying it all back as dividends. So, while an oil or gas company may be profitable for you through dividends if you buy their stock, only an examination of their P/E will tell you if the stock itself is likely to go up in value or not as time passes.

This is why P/E is so crucial. If you’re not taking that into consideration, how can you ever know what a company’s true value is – not their “perceived” value, which could be inflated by Reddit traders and evaporate just as quickly if the company doesn’t have any underlying earnings – but it’s true, long-term value, based on what its profits and earnings are now, and what those profits and earnings are likely to be in the future, as well. You can’t be a Money Maker if you don’t consider all the ins and outs of making money – good luck!

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