Berkshire Hathaway class A shares trade at hundreds of thousands of dollars. That is the price for each share.
Apple shares trade at hundred and some dollars a piece.
And the shares of Uber trade at a twenty plus dollars.
So Uber stock is cheaper than Apple stock and Apple stock is cheaper than Berkshire Hathaway stock?
Of course not.
A ten-dollar stock is not cheaper than a hundred-dollar stock. A hundred-dollar stock is not cheaper than a thousand-dollar stock. A thousand-dollar stock is not cheaper than a million-dollar stock.
To understand why, we start with market capitalization. I’ve highlighted that in red above along with the P/E or the price over earnings ratio for each of the businesses shown.
Market capitalization (market value) of a publicly traded business is its stock price times the number of shares that are outstanding.
Market capitalization = Stock price x Number of shares outstanding
Apple’s market value as of the date of this post is about two trillion dollars. So if you wanted to buy the whole of Apple as a business, you’ll need to come in with that much money.
How many Apple shares are out there in the market? That is market capitalization divided by the stock price so about 16 billion shares.
Apple can decide tomorrow to split its shares and give you ten shares for each of share you own. What will that do to its stock price? It will drop by a factor of ten.
What should that do to the market value of Apple? Nothing except for some dumb reason, people think they are getting a deal so demand for the shares rise and so does the price. That is just noise and the price eventually settles down to the true value. And it does not always happen so if you think you’ve found some secret to make money…you haven’t.
Now we get to valuation. Wish life was that easy but the price to earnings ratio is the first thing you go to get a feel of how much return are you getting for each of your investment dollars. Berkshire trades at a price to earnings ratio of eight (7.89) so its earning yield which is the inverse of P/E is 12.5 percent.
The same yield for Apple is 4.5 percent, so quite a bit more expensive than Berkshire.
And Uber has never made money. It does not have a price to earnings ratio yet.
So Berkshire even when it trades at hundreds of thousands of dollars a share is in fact a bargain compared to Apple and Apple a much better bargain compared to Uber.
I know and hopefully you know that that’s a very rudimentary view on valuation but you get the point. Stock price in and of itself does not mean anything. It is the market capitalization and how much profit a business makes in relation to that market capitalization is what decides whether a business is valued as a bargain or not.
And in this day and age when you can buy fractional shares, the price of a stock is meaningless.
So when you see headlines like this…
Or this…
…just be entertained and go about your way.
Thank you for your time.
Cover image credit – Lucas George Wendt