6 ms·

Using p/e to value growth companies doesn't work too well. The "E" in the ratio changes too fast.

scottjad 11y ago
If the P/E ratio had been very low, I think he would have used it. The problem with using P/E for an eleven year old company like Yelp is that E is still very small or non-existant and hasn't been changing fast, so the P looks ridiculous.
Ologn 11y ago
> Using p/e to value growth companies doesn't work too well. The "E" in the ratio changes too fast. In 1934, Benjamin Graham and David Dodd published "Security Analysis" which laid out the basis of modern thinking on proper fundamental stock price, both by academics and by mutual fund managers. What you're saying completely contradicts that. Something else is forgotten - the real price is not determined by the p/e ratio but in something even more concrete - the price/dividend ratio. Enron might be fudging their books, but nothing fudges the quarterly dividends. Price/earnings is already an abstraction of what determines the real price - the price/dividend ratio. You're talking about abstracting things yet further - it reminds me of the late 1990s when people talked about price as related to "eyeballs". It's true that a p/e ratio is meaningless when a company is very small - before product/market fit and so forth. But P/E has forever been used to value technological growth companies. Technological growth companies are not a new thing - there were companies like Cisco in the 1990s and like Polaroid in the 1970s. High growth companies have high p/e ratios. It's already abstracted from price/dividend to price/earnings. Then there are companies like Amazon, which are a whole other tangent off this.
- JoeAltmaier 11y ago
  I've heard this idea that dividends determine a stock value, but I've never believed it. I guess for some definitions of the word 'value', because the dividend, if any, has little or nothing to do with the bid or ask prices on the exchange. When dividend time comes near (for annual dividends) the stock price ramps up by the expected/announced dividend, then poof! it drops by that price after. So for most of the year the potential dividend is factored in at nearly zero$. Also preferred shares issue dividends, right? So all the rest - what is their 'value' by this strange definition? Folks can pretend there is some holy, true value of the stock that can be determined from the history of dividends. But good luck buying or selling your shares based on that number.
  - jacquesm 11y ago
    There are quite few direct roads to investing based on dividends alone and there are also a whole bunch of products directly targeting high dividend yield stocks. Surely the people buying/selling those stocks and funds are buying and selling based on that number. It's just a different strategy, not very popular in the startup world but for more established companies it is not unheard of.
    - JoeAltmaier 11y ago
      Sure that makes sense. But academics insist that all stocks have value based on their dividends. My local prof of finance (and old high school friend/poker buddy) is one. I can't fathom how the ivory tower types come up with this nonsense.
      - jacquesm 11y ago
        > But academics insist that all stocks have value based on their dividends. That's a strange statement (by the academics, not by you!) since quite a few companies stocks are traded that have to date never issued a single dividend and that may not issue dividends for a quite a while to come. And still somehow the market seems to be able to assign a value to those stocks. I think that one way of interpreting this is that - just like with start-up valuations - as long as you're growing / adapting / investing dividends are out of the question and the value is mostly based on the story and the dream. Turnover and other numbers are useful but ultimately not as useful as money returned to investors (otherwise, why invest at all?). But once the moment of dividend arrives (and growth / investment) have stopped and the company is now in its middle age that those dividends will be the marker used to re-calibrate the value of the stock. Dividends are a lot easier to use as an input into a formula than dreams and stories which are just repackaged hope. That's one reason why I find it nearly impossible to put a hard number on the value of a start-up, it's essentially asking for a crystal ball.
        tptacek 11y ago
        It's not a strange statement. Stocks that don't pay dividends would still appreciate because investors are pricing in either the dividends the company will pay in the future, or the value the company will have to the dividends of the company that will eventually acquire it.
- wtvanhest 11y ago
  P/E ratios are just one factor that professional investors use to analyze companies. P/E ratios may be really high while not being alarming when it is in the company's best interest to invest in growth. When the company can invest excess profits (contribution margin) in growth, the company can make zero money in earnings while still rapidly growing revenue. That is a really great situation and if you do not buy that stock because of the high p/e ratio, you will have missed a major opportunity. Dividends go a step further. If a company believes that paying dividends is the best use of the company's capital, that means the company has theoretically run out of growth opportunities to invest in. Understanding finance is a lot more complicated than reading and understanding a single book written in 1934. If you want to learn a lot more about how unimportant P/E ratios are, you can read about factor based stock analysis or financial econometrics.
- amunicio 11y ago
  The price earning ratio is useful to compare companies in the same industry that are targeting the same growth level. If P/E was any good indicator of value (in the absolute) the total market cap of Amazon should have been close to $0 during any of these quarters when it barely broke even. I'm not implying that the P/E is worthless, just that it should be carefully applied and in some cases it shouldn't be applied at all.
- steveplace 11y ago
  There is growth investing and there is value investing. One isnt the end-all, and both have merits. I am more of the growth side of things so i will look at a metric like price to sales or sales growth to get a better idea on what investors are expecting. My point here I guess is if youre looking at a growth stock, you should be looking at how eps are growing and how they will grow in the future, not the price right now. Maybe its that i have seen too many scream about p/e on something like NFLX or CRM or AMZN (because they don't back out capex)... And then the stock contiunes to run as earnings grows.
adventured 11y ago
No it doesn't. Yelp 2013: -$19m; 2014: -$10m; 2015: $36m I can keep up with that very modest shift to profitability just fine. For example, a boring chicken company, considered a low growth company, produces faster earnings growth than that and nobody seriously has a hard time valuing them. Nobody would claim you can't value said boring chicken company because their earnings are growing too quickly. Sanderson Farms (SAFM) net income 2012: $54m; 2013: $130m; 2014: $249m They're currently trading for six times their last full fiscal year's earnings, and perhaps seven times 2015 earnings. They're growing earnings radically faster than Yelp. Yelp is doing anything but growing earnings too fast to be able to keep up with it. The idea that you can't value growth companies because things change too much, is nothing more than an attempt to get investors to pay outrageously high multiples for the same earnings they can get elsewhere for far cheaper.
- hugh4 11y ago
  > The idea that you can't value growth companies because things change too much, is nothing more than an attempt to get investors to pay outrageously high multiples for the same earnings they can get elsewhere for far cheaper. Not necessarily, I'd say it's a valid principle, but not one that applies to yelp.
- jrock08 11y ago
  Revenue is a much better indicator of growth. Yelp 2012: 137M; 2013: 232M; 2014: 377M SAFM 2012: 2.3B 2013: 2.6B 2014: 2.7B So, SAFM grew ~5% while Yelp grew 100%
  - dkrich 11y ago
    I think that's a pretty huge oversimplification. In terms of dollars, SAFM's growth alone is larger than Yelp's gross revenue. Apart from that, those numbers tell nothing about cost- if Yelp's customer acquisition costs rose more than the revenue, then they are just paying a dollar for $.50. Further, if the social media sector of the market rose 200% overall, then Yelp is actually underperforming the market. There's not a single "best" indicator of growth. You have to examine multiple facets of a company's performance- revenue, costs, overall market performance, sector performance, etc. to understand a company's growth.

If the P/E ratio had been very low, I think he would have used it. The problem with using P/E for an eleven year old company like Yelp is that E is still very small or non-existant and hasn't been changing fast, so the P looks ridiculous.

Ologn 11y ago

> Using p/e to value growth companies doesn't work too well. The "E" in the ratio changes too fast. In 1934, Benjamin Graham and David Dodd published "Security Analysis" which laid out the basis of modern thinking on proper fundamental stock price, both by academics and by mutual fund managers. What you're saying completely contradicts that. Something else is forgotten - the real price is not determined by the p/e ratio but in something even more concrete - the price/dividend ratio. Enron might be fudging their books, but nothing fudges the quarterly dividends. Price/earnings is already an abstraction of what determines the real price - the price/dividend ratio. You're talking about abstracting things yet further - it reminds me of the late 1990s when people talked about price as related to "eyeballs". It's true that a p/e ratio is meaningless when a company is very small - before product/market fit and so forth. But P/E has forever been used to value technological growth companies. Technological growth companies are not a new thing - there were companies like Cisco in the 1990s and like Polaroid in the 1970s. High growth companies have high p/e ratios. It's already abstracted from price/dividend to price/earnings. Then there are companies like Amazon, which are a whole other tangent off this.

JoeAltmaier 11y ago
I've heard this idea that dividends determine a stock value, but I've never believed it. I guess for some definitions of the word 'value', because the dividend, if any, has little or nothing to do with the bid or ask prices on the exchange. When dividend time comes near (for annual dividends) the stock price ramps up by the expected/announced dividend, then poof! it drops by that price after. So for most of the year the potential dividend is factored in at nearly zero$. Also preferred shares issue dividends, right? So all the rest - what is their 'value' by this strange definition? Folks can pretend there is some holy, true value of the stock that can be determined from the history of dividends. But good luck buying or selling your shares based on that number.
- jacquesm 11y ago
  There are quite few direct roads to investing based on dividends alone and there are also a whole bunch of products directly targeting high dividend yield stocks. Surely the people buying/selling those stocks and funds are buying and selling based on that number. It's just a different strategy, not very popular in the startup world but for more established companies it is not unheard of.
  - JoeAltmaier 11y ago
    Sure that makes sense. But academics insist that all stocks have value based on their dividends. My local prof of finance (and old high school friend/poker buddy) is one. I can't fathom how the ivory tower types come up with this nonsense.
    - jacquesm 11y ago
      > But academics insist that all stocks have value based on their dividends. That's a strange statement (by the academics, not by you!) since quite a few companies stocks are traded that have to date never issued a single dividend and that may not issue dividends for a quite a while to come. And still somehow the market seems to be able to assign a value to those stocks. I think that one way of interpreting this is that - just like with start-up valuations - as long as you're growing / adapting / investing dividends are out of the question and the value is mostly based on the story and the dream. Turnover and other numbers are useful but ultimately not as useful as money returned to investors (otherwise, why invest at all?). But once the moment of dividend arrives (and growth / investment) have stopped and the company is now in its middle age that those dividends will be the marker used to re-calibrate the value of the stock. Dividends are a lot easier to use as an input into a formula than dreams and stories which are just repackaged hope. That's one reason why I find it nearly impossible to put a hard number on the value of a start-up, it's essentially asking for a crystal ball.
      - tptacek 11y ago
        It's not a strange statement. Stocks that don't pay dividends would still appreciate because investors are pricing in either the dividends the company will pay in the future, or the value the company will have to the dividends of the company that will eventually acquire it.
wtvanhest 11y ago
P/E ratios are just one factor that professional investors use to analyze companies. P/E ratios may be really high while not being alarming when it is in the company's best interest to invest in growth. When the company can invest excess profits (contribution margin) in growth, the company can make zero money in earnings while still rapidly growing revenue. That is a really great situation and if you do not buy that stock because of the high p/e ratio, you will have missed a major opportunity. Dividends go a step further. If a company believes that paying dividends is the best use of the company's capital, that means the company has theoretically run out of growth opportunities to invest in. Understanding finance is a lot more complicated than reading and understanding a single book written in 1934. If you want to learn a lot more about how unimportant P/E ratios are, you can read about factor based stock analysis or financial econometrics.
amunicio 11y ago
The price earning ratio is useful to compare companies in the same industry that are targeting the same growth level. If P/E was any good indicator of value (in the absolute) the total market cap of Amazon should have been close to $0 during any of these quarters when it barely broke even. I'm not implying that the P/E is worthless, just that it should be carefully applied and in some cases it shouldn't be applied at all.
steveplace 11y ago
There is growth investing and there is value investing. One isnt the end-all, and both have merits. I am more of the growth side of things so i will look at a metric like price to sales or sales growth to get a better idea on what investors are expecting. My point here I guess is if youre looking at a growth stock, you should be looking at how eps are growing and how they will grow in the future, not the price right now. Maybe its that i have seen too many scream about p/e on something like NFLX or CRM or AMZN (because they don't back out capex)... And then the stock contiunes to run as earnings grows.

adventured 11y ago

No it doesn't. Yelp 2013: -$19m; 2014: -$10m; 2015: $36m I can keep up with that very modest shift to profitability just fine. For example, a boring chicken company, considered a low growth company, produces faster earnings growth than that and nobody seriously has a hard time valuing them. Nobody would claim you can't value said boring chicken company because their earnings are growing too quickly. Sanderson Farms (SAFM) net income 2012: $54m; 2013: $130m; 2014: $249m They're currently trading for six times their last full fiscal year's earnings, and perhaps seven times 2015 earnings. They're growing earnings radically faster than Yelp. Yelp is doing anything but growing earnings too fast to be able to keep up with it. The idea that you can't value growth companies because things change too much, is nothing more than an attempt to get investors to pay outrageously high multiples for the same earnings they can get elsewhere for far cheaper.

hugh4 11y ago
> The idea that you can't value growth companies because things change too much, is nothing more than an attempt to get investors to pay outrageously high multiples for the same earnings they can get elsewhere for far cheaper. Not necessarily, I'd say it's a valid principle, but not one that applies to yelp.
jrock08 11y ago
Revenue is a much better indicator of growth. Yelp 2012: 137M; 2013: 232M; 2014: 377M SAFM 2012: 2.3B 2013: 2.6B 2014: 2.7B So, SAFM grew ~5% while Yelp grew 100%
- dkrich 11y ago
  I think that's a pretty huge oversimplification. In terms of dollars, SAFM's growth alone is larger than Yelp's gross revenue. Apart from that, those numbers tell nothing about cost- if Yelp's customer acquisition costs rose more than the revenue, then they are just paying a dollar for $.50. Further, if the social media sector of the market rose 200% overall, then Yelp is actually underperforming the market. There's not a single "best" indicator of growth. You have to examine multiple facets of a company's performance- revenue, costs, overall market performance, sector performance, etc. to understand a company's growth.