Beauty is in the eye of the beholder. In the stock market, the term “value” is one of the words that essentially models that same description — that is to say, it depends on who is doing the judging.
A glass of water might conjure a host of different meanings from half-full to half-empty or even the idea that it might be time to short water and go long on glassware. Still, the reality is that which makes up valuation is all relative.
In this article, we are going to discuss a few stocks that are constantly in the forefront of the valuation discussion and try to answer the prevailing question of whether or not stocks always reflect a company’s underlying value.
We are going to look at four names: Apple ($AAPL), Facebook ($FB), Amazon ($AMZN) and Salesforce.com ($CRM). We will try to determine the source of the mistake that investors continue to make — confusing “price” with “value,” two entirely separate things.
Do Valuations Really Matter?
Warren Buffett has always reminded us that “price” is what you pay and “value” is what you get. However, that has not always been reflected in how stocks are bought and sold.
The perfect example of this is Apple when compared to Amazon, Facebook and Salesforce.com, all three sporting much higher price-to-earnings ratios. What this tells me is that if the market was efficient or if “all things were equal,” Apple should be trading at least in the $1,200s by now.
However, as it stands Apple remains the cheapest stock on the market when assessing not only its current fundamentals, but its forward-looking potential.
Consider this: Over the past five years Amazon has had the label of being one of the most expensive stocks on the market and has never averaged a P/E of less than 80 during that span. The stock can’t stop making new highs.
Yet, Apple, as the largest company in the world, with a cash hoard that makes the U.S. Treasury envious, can’t seem to trade higher than a multiple of 17. It gets even more outrageous when one compares Apple to Salesforce.com, a company that trades at a price-to-earnings ratio that is literally off the charts. However, Salesforce is not profitable.
Yet, investors insist it remains a good bet and think that a price of $145 today is great value while its growth prospects do not support such a high P/E.
What’s more, even on the most bullish assumptions, the stock remains expensive. So I question the rationale in choosing Salesforce over Apple. Even if the term “diversification” is applied it still wouldn’t make sense.
This brings us to Facebook, the poster child for valuation disconnect. I once reminded investors the company had no business being compared to Apple, or for that matter Amazon.
However, we have since come to realize that investors had other ideas, many of which they now regret. Consider how easy it would have been to assess Facebook’s valuation worthiness by applying Apple’s logic.
The fact of the matter is, investors would have saved themselves a considerable amount of heartache if they realized the failed logic of valuing a company that “does not make anything” at $100 billion. Making matters worse was the idea that Facebook’s trading multiple would top that of Apple, which makes virtually everything that consumers can’t be without.
Instead, what happened was that investors decided to make up their own minds as to how to value Facebook despite any signs of weakness the company might have warned about. Today, with the stock trading over 50% below its initial public offering high of $45, investors are ready to punish the company instead of striving to understand the obvious lesson. Facebook’s challenge remains trying to prove the value of social media. Not necessarily its relevance — that much is known. What is not known is how much it is worth.
So the question is, do valuations really matter? When all of these points are put together it is staggering how undervalued it makes Apple appear – even today. It doesn’t make much sense.
Or is it better to invest on a more obscure metric? Investors will typically send a company’s stock higher on the assumption that in 12 to 24 months from the time of purchase the stock will grow and be met by increased value. Except it doesn’t always work. Not every company’s promise is returned in value.
There are those companies that boast about how the sky is the limit and there are those such as Apple that prove every quarter what true limitless execution is all about.
Without a doubt, Apple remains the cheapest stock on the market now and for the foreseeable future.
At the time of publication, the author was long AAPL and held no position in any of the other stocks mentioned.
This article was written by an independent contributor, separate from Wall Street Playbook’s regular news coverage.