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> 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

by 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.
        JoeAltmaier 11y ago
        Again insistence that stock traders are all about dividends, on no evidence whatsoever? Folks trade stocks because the bid and ask overlap; that's it. There's nothing else going on, except in people's heads. Fictitious future dividends are ... fictitious! Good luck trying to sell your stock for anything but what its going for on the day you sell. Any cries of 'but dividends! Its worth X!" will be drowned out by the marketplace. And the evidence points to, there's no accommodation for dividends in the price. Stocks ramp up in the month before dividends are issued; drop that day. That's all the market does to accommodate dividends.
- fredkbloggs 11y ago
  Have you ever heard that price is what you pay, and value is what you get? The people who understand this look at dividends. The rest buy companies like Amazon for silly multiples. P.S. Preferreds may or may not pay dividends. The preferreds that VCs get almost never do. If you own preferreds that do, you probably value them the way you value anything else: present value of future payments.
  - JoeAltmaier 11y ago
    That sounds like 'sour grapes'. Sure, folks can pay crazy prices but not me! I won't participate in all that profit nonsense. The only value you usually get from most shares, is what you sell it for. And that depends only upon the market. Not some academic definition of 'value'.
    - fredkbloggs 11y ago
      > That sounds like 'sour grapes'. Believe me, it isn't. I'm no trader and have no interest in speculation. I'm perfectly happy collecting my dividends (that profit "nonsense", as you put it) while you boys do your thing. > I won't participate in all that profit nonsense. Riddle me this, then. A company is founded. Takes a few rounds, goes public. Billions of its shares are traded for years. Then it goes bankrupt, and all those shares are canceled. Who profited? Trading is a zero-sum game by its nature. The profits, if any, accrued to those who were paid dividends. For every trade, show me a winner and I'll show you a loser. It's fine to bet on the horses. Good fun, fresh air and a pleasant day at the track. Nothing wrong with it. Maybe you'll even get lucky! But if you want to make the sure money, you're better off owning the track... or the horses. > The only value you usually get from most shares, is what you sell it for. This couldn't possibly be more wrong. As I just explained, the true and total value (using your definition of CASH MONEY) of any corporation is the dividends it pays. Otherwise, there's a loser for every winner in the trading game. If you only own shares that don't pay dividends, I can understand how you might fall into this way of thinking, but that doesn't make it right. This is a product of various cognitive biases, among them the Dunning-Kruger effect, the bandwagon effect, recency, groupthink, survivorship, and many others. It feels good to believe that one is a better-than-average trader, that one has skill in trading and can consistently and reliably make money doing it. Because it's often possible to make money without skill, even for periods of time that are large fractions of a human life, it's easy to draw that conclusion, especially when it seems like everybody is making money trading as is often the case in bull markets. Because one is making money trading (or believes he is; it's easy to overlook the bad trades if you don't keep a good accounting, and even easier to imagine unrealized market price gains as if they were CASH MONEY when in fact they are nothing), it's easy to assume that it's the result of skill. But most traders have zero or negative skill, and like the gambler who always lets it ride, will eventually go broke. I don't really care whether you trade. I don't really care whether you make money or lose money trading (the odds are not in your favor). I certainly don't care what assets you choose to own. But don't tell me that the income I receive from owning -- not trading -- solid businesses isn't profit, or that your way is better than mine. When people start talking like you, I begin to wonder if we once again have a generation of traders in the markets who have never experienced a crash or a secular bear market. Those unrealized gains can turn into losses and margin calls awful fast when things go to shit. Yet shockingly often, even while prices crater, the dividends keep coming.
- syllogism 11y ago
  Dividends can underwrite the value even if never issued, the same way a government guarantee can make debt 0-risk even if the guarantee is never exercised. Contrast with a "tulip economy", like bitcoin, where there is no intrinsic value — only investor sentiment/expectation. Bitcoin and gold are worth money because you expect others to expect others to expect etc it to continue to be worth money. Time-discounted expected future dividends act as shared knowledge: everyone knows that if the price dropped below a certain point, the company can start issuing dividends and the price would immediately recover. Because everyone knows that, the price never has to drop that far, and it's never necessary.
- zodiac 11y ago
  Not really, it's the expected future value of dividends (plus the value in assets of the company and in voting rights, but these are normally much smaller than the value of the future value of dividends). People buy growth company stocks based on the belief that in 10 years, the company will be huge and they'll start paying dividends. > Also preferred shares issue dividends, right? So all the rest - what is their 'value' by this strange definition? Common stock can pay dividends as well. If you still don't believe me, let me ask you - if tomorrow Google announced that they would never ever pay a dividend ever, how much would their stock be worth? Why would anyone buy Google stock in that case?
  - lmm 11y ago
    Google did say that, when they first went public. The markets ignored it (and it seems they were right to; Google may not technically have paid a dividend but they reverse-span-out Alphabet which has, which is economically the same thing).
- lmm 11y ago
  Financiers are perfectly happy to value things quite abstractly. I mean, you can buy CDS on Kazakhstan - that is, insurance on bonds that don't exist. And they trade, at reasonably stable prices. Exactly how much is in this year's dividend doesn't really matter most of the time - if they pay a penny less this year that's one more penny in their vaults for them to pay out next year (or invest in the business and pay out further down the line). I mean, what else are they going to do with it? (The exception is generally poorly managed companies who might waste the penny instead - and in those cases activists often can dramatically increase the price by encouraging the company to pay a big dividend right now and keep less cash in the bank). But the dividends are where the rubber meets the road, the foundation on which any valuation ultimately rests. And in the long run companies either die or become the kind of stable, dividend-paying stock that makes less headlines and is valued pretty directly on PE that actually makes up most of the market.
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.

by Ologn 11y ago

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.
      - JoeAltmaier 11y ago
        Again insistence that stock traders are all about dividends, on no evidence whatsoever? Folks trade stocks because the bid and ask overlap; that's it. There's nothing else going on, except in people's heads. Fictitious future dividends are ... fictitious! Good luck trying to sell your stock for anything but what its going for on the day you sell. Any cries of 'but dividends! Its worth X!" will be drowned out by the marketplace. And the evidence points to, there's no accommodation for dividends in the price. Stocks ramp up in the month before dividends are issued; drop that day. That's all the market does to accommodate dividends.
fredkbloggs 11y ago
Have you ever heard that price is what you pay, and value is what you get? The people who understand this look at dividends. The rest buy companies like Amazon for silly multiples. P.S. Preferreds may or may not pay dividends. The preferreds that VCs get almost never do. If you own preferreds that do, you probably value them the way you value anything else: present value of future payments.
- JoeAltmaier 11y ago
  That sounds like 'sour grapes'. Sure, folks can pay crazy prices but not me! I won't participate in all that profit nonsense. The only value you usually get from most shares, is what you sell it for. And that depends only upon the market. Not some academic definition of 'value'.
  - fredkbloggs 11y ago
    > That sounds like 'sour grapes'. Believe me, it isn't. I'm no trader and have no interest in speculation. I'm perfectly happy collecting my dividends (that profit "nonsense", as you put it) while you boys do your thing. > I won't participate in all that profit nonsense. Riddle me this, then. A company is founded. Takes a few rounds, goes public. Billions of its shares are traded for years. Then it goes bankrupt, and all those shares are canceled. Who profited? Trading is a zero-sum game by its nature. The profits, if any, accrued to those who were paid dividends. For every trade, show me a winner and I'll show you a loser. It's fine to bet on the horses. Good fun, fresh air and a pleasant day at the track. Nothing wrong with it. Maybe you'll even get lucky! But if you want to make the sure money, you're better off owning the track... or the horses. > The only value you usually get from most shares, is what you sell it for. This couldn't possibly be more wrong. As I just explained, the true and total value (using your definition of CASH MONEY) of any corporation is the dividends it pays. Otherwise, there's a loser for every winner in the trading game. If you only own shares that don't pay dividends, I can understand how you might fall into this way of thinking, but that doesn't make it right. This is a product of various cognitive biases, among them the Dunning-Kruger effect, the bandwagon effect, recency, groupthink, survivorship, and many others. It feels good to believe that one is a better-than-average trader, that one has skill in trading and can consistently and reliably make money doing it. Because it's often possible to make money without skill, even for periods of time that are large fractions of a human life, it's easy to draw that conclusion, especially when it seems like everybody is making money trading as is often the case in bull markets. Because one is making money trading (or believes he is; it's easy to overlook the bad trades if you don't keep a good accounting, and even easier to imagine unrealized market price gains as if they were CASH MONEY when in fact they are nothing), it's easy to assume that it's the result of skill. But most traders have zero or negative skill, and like the gambler who always lets it ride, will eventually go broke. I don't really care whether you trade. I don't really care whether you make money or lose money trading (the odds are not in your favor). I certainly don't care what assets you choose to own. But don't tell me that the income I receive from owning -- not trading -- solid businesses isn't profit, or that your way is better than mine. When people start talking like you, I begin to wonder if we once again have a generation of traders in the markets who have never experienced a crash or a secular bear market. Those unrealized gains can turn into losses and margin calls awful fast when things go to shit. Yet shockingly often, even while prices crater, the dividends keep coming.
syllogism 11y ago
Dividends can underwrite the value even if never issued, the same way a government guarantee can make debt 0-risk even if the guarantee is never exercised. Contrast with a "tulip economy", like bitcoin, where there is no intrinsic value — only investor sentiment/expectation. Bitcoin and gold are worth money because you expect others to expect others to expect etc it to continue to be worth money. Time-discounted expected future dividends act as shared knowledge: everyone knows that if the price dropped below a certain point, the company can start issuing dividends and the price would immediately recover. Because everyone knows that, the price never has to drop that far, and it's never necessary.
zodiac 11y ago
Not really, it's the expected future value of dividends (plus the value in assets of the company and in voting rights, but these are normally much smaller than the value of the future value of dividends). People buy growth company stocks based on the belief that in 10 years, the company will be huge and they'll start paying dividends. > Also preferred shares issue dividends, right? So all the rest - what is their 'value' by this strange definition? Common stock can pay dividends as well. If you still don't believe me, let me ask you - if tomorrow Google announced that they would never ever pay a dividend ever, how much would their stock be worth? Why would anyone buy Google stock in that case?
- lmm 11y ago
  Google did say that, when they first went public. The markets ignored it (and it seems they were right to; Google may not technically have paid a dividend but they reverse-span-out Alphabet which has, which is economically the same thing).
lmm 11y ago
Financiers are perfectly happy to value things quite abstractly. I mean, you can buy CDS on Kazakhstan - that is, insurance on bonds that don't exist. And they trade, at reasonably stable prices. Exactly how much is in this year's dividend doesn't really matter most of the time - if they pay a penny less this year that's one more penny in their vaults for them to pay out next year (or invest in the business and pay out further down the line). I mean, what else are they going to do with it? (The exception is generally poorly managed companies who might waste the penny instead - and in those cases activists often can dramatically increase the price by encouraging the company to pay a big dividend right now and keep less cash in the bank). But the dividends are where the rubber meets the road, the foundation on which any valuation ultimately rests. And in the long run companies either die or become the kind of stable, dividend-paying stock that makes less headlines and is valued pretty directly on PE that actually makes up most of the market.

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.