Philip Elmer-DeWitt noted something interesting on Saturday in Fortune magazine, Amazon’s price-to-earnings ratio is now 2,767. Apple’s is 13! In the last quarter, Apple’s earnings were up and the stock went down, whereas Amazon reported a loss and the stock went up.
When a company reports bumper earnings, I assume its stock price should rise, and when a company takes a loss, the stock price should fall. After all, the stock price is really the public valuation of the company. So this response to earnings makes no sense to me. I decided to investigate this madness to see if there are any other rational indicators that explain it. Instead, I found support for my thesis, and no answer to why this is happening.
3 Month Performance
Here is a chart of AAPL vs AMZN (with friends MSFT and PEP as the “blue-chips”) for the past three months:
So, over the past 3 months, AAPL is down 5.33%, AMZN only 1.25% down, whereas MSFT, PEP, DOW and the Nasdaq are all pretty flat. Why is AAPL down more than AMZN? The short term view makes no sense.
Return on Equity
Since most investment decisions are made over a longer view, lets look at the Return on Equity (ROE) ratios over five (5) years. The ROE tells us how much money a company is making for its investors, i.e. if a company spends $100 to make something, and sells it for $120, it makes a profit of $20, or an ROE of 20%:
This tells quite a story. Over the past 5 years, AAPL’s ROE has been trending upwards, i.e. AAPL is becoming more profitable. This is amazing given that we’ve been through the toughest recession since the Great Depression. MSFT and PEP have held their own as blue-chips should, but look at the downward slope of AMZN, it’s too steep to ski down! AMZN has gone from a company that generates massive profits to a company that makes a loss, and the trend is not looking good. So, using past performance, AMZN’s shares should have dropped like a rock. Instead, they have gone up by 170.27% over 5 years vs AAPL’s 209.2%. What? Something is wrong here.
Earnings per Share
Lets try Earnings per Share (EPS) instead. EPS the amount of money the company actually earns for each share of stock that is outstanding. It should increase each year as the company grows.
Wow, AAPL’s EPS has gone ballistic, so the stock should have gone ballistic too. AMZN, however, has gone from almost nothing positive EPS to negative, so the share price should have tanked. Did not!
Price / Earnings Ratio
This is the number that triggered this post. The Price / Earnings Ratio (P/E) is one way investors use to determine how much a stock costs compared with how much the company earns. Think of it as the number of years it would take for the earnings of the company to pay back your share purchase cost. A good P/E should be in line with the industry average (I prefer above average), and it should remain steady, it should not move around too much. As a simplification, a cheap share is one where the P/E suddenly drops after being nice and steady, and an expensive share is one where the P/E rises suddenly after being nice and steady. Lets take a look:
AAPL, MSFT and PEP are nice and steady, with AAPL’s P/E dropping as it’s profitability increases, as expected. AMZN’s P/E is quite high and volatile. But over the last year, the P/E for AMZN has popped right off the chart. See the chart to the right. AMZN’s P/E on Sep 30 was 3,633 vs AAPL’s of 15.11. Or in other words, AAPL will pay back in 15 years and AMZN when the sun goes cold. Using P/E as an indicator to make investment decisions, AMZN’s volatile P/E means you should not buy it (and sell what you have) and the upwards jump indicates an urgent sell and a do-not-touch. Yet still the AMZN share price went up. What?
So what could it be?
I have several theories why AMZN shares are up, none of which are probably valid:
- Investors and analysts are not looking at the numbers. Or they are looking at the numbers and do not understand them.
- Or, the large number of anti-AAPL, pro-AMZN articles in the press are swaying investor opinion.
- Or, Jeff Bezos has his own reality distortion field.
- Or, hedge funds are pushing AAPL down so that when it pops, it pops big for them (they are all long AAPL and would love to buy more at depressed prices). And they are artificially inflating AMZN shares for some unknown reason.
- Or, people are investing with emotion not facts.
- Or, the disruption theory applies. Amazon has successfully disrupted the book business, shoe business and many other retail businesses by selling lead products at a loss (and consumables, such as the books themselves, at very low margin that no-one can beat), and investors are betting that at some point AMZN will push its prices up once the competition is finally buried.
Whatever the reason, the fundamentals show that AAPL shares are undervalued, and AMZN shares are ridiculously bubble-level overvalued. Yet only one other person seems to be asking why, Philip Elmer-DeWitt.