In the end when we try to figure out what to pay for stocks all we have are mundane yardsticks, such as total addressable market, also known as the degree of opportunity that is available, and the price-to-earnings multiple, and, to a lesser extent, the price-to-sales multiple versus the growth rate.
I certainly wish there were more to it, some secret sauce that allows apples to apples comparisons and makes the decision to buy one stock over another quite easy.
Now to some degree it is more of an art than a science. If you are trying to figure out the value of Netflix (NFLX) , which barely has any earnings, you are hostage to the total addressable market for internet entertainment around the world. It's only that kind of thinking that allows you to say it is reasonable that Netflix is worth almost four times the value of CBS (CBS) .
Similarly, you either believe in Jeff Bezos or Elon Musk with Amazon (AMZN) and Tesla (TSLA) or you don't. It's your call. I think Amazon has a tremendous amount of worth, whether it be the retail business or the Amazon Web Services, or cloud business. I can see those worth $750 billion and $250 billion respectively, which would mean this stock could double. When you put it in that perspective you can see how the couple of days selling off might be regarded as a long-term buying opportunity. Tesla? Totally beauty in the eye of the beholder because it has no earnings and the company's history of making its projections is quite spotty. But if you regard it as a tech stock and not an auto stock, you can rationalize the price.
There are, however, instances where valuation is totally mystifying and the confusing nature of the mystery has to do with a perception about what's expensive and what's cheap.
For example, let's take the stock of Colgate (CG) . We know this is a totally respectable brand and a well run company. That's why despite its 7% growth rate it has a 24 P/E multiple on next year's numbers. No one ever hesitates to buy the stock of Colgate with those figures. Clorox (CLX) , another respectable brand that has sold bleach for more than 100 years, has a 25 P/E multiple and a 5% growth rate. I don't know a soul who says "look out for that one." Kimberly Clark (KMB) , the tissue company, sports an 18 P/E on 2018 earnings with a 5% growth rate. Again, that's totally acceptable even versus Clorox which has an earnings growth profile that is improving.
We all accept these valuations despite meager dividends that wouldn't even come near protecting you on the downside.
However, what do we routinely regard as expensive, including days like yesterday? Stocks like those of Apple (AAPL) , Alphabet (GOOGL) and Facebook (FB) which, last I look, have much bigger total addressable markets than any of those consumer packaged goods companies.
But let's perform the same exercise. Apple's got a huge upgrade cycle that some are predicting could provide growth of up to 25%. Let's say that's pie in the sky. Let's say it grows at half of that. Its P/E multiple on that number? Fifteen. So you have almost three times the growth rate on a monster haircut and yet a P/E multiple that is reasonable as an apples to apples comparison versus all of those companies. How about Alphabet? Here's a company with a 17% growth rate that sells at 24 times earnings. Now you are talking about more than three times the growth rate and roughly the same multiple as bleach for heaven's sake.
When I look at Facebook I like to examine the so-called outyears because that has, historically, been the best judge of how it's been doing. The analysts are predicting 21% growth rate with a 21 P/E multiple.
Yesterday we sold all of the tech stocks down hard including ones where the future's rosy, versus the commodities like makers of disk drives or flash memory. But we took the consumer packaged goods stocks higher. Why didn't I abandon tech? Because the stocks I like, the stocks I own for my charitable trust, are simply cheaper on a P/E basis than the household names.Now, sure there are stocks that get ahead of themselves. There are moments where the growth of all of these stocks is in question. But if you are trying to figure out what to pay for a stock, this exercise is both instructive and dispositive. Or, another way to say it: get over that tech's so much more expensive than you think it is. Do the work, you will find that you are wrong. Dead wrong.