Ask yourself this, “What do I look at before I buy a stock?” Chances are you don’t look at what you should be loking at. Just looking at a stocks chart, revenue, profits, and what tik tok says is not a good valuation. Once you start investing with bigger sums of money, you can’t afford to make mistakes as often.
Looking at more in depth metrics and numbers gives a better understanding if a stock is expensive or not. The metrics I am about to share are not complex, so don’t run away too early. In fact, they are based off of what you’ve been looking at already. The revenue, profits, and growth percentages.
Most metrics can be found easilly on yahoo finance.
Keep This In Mind
The best way to determine whether a stock is cheap or expensive is to compare it with it’s closest competitors. If one company’s numbers are inflated when compared to the other it could mean the stock is overvalued. Not always, but it could.
Comparing analytics on Starbucks ($SBUX) vs. Tesla ($TSLA) for example, may steer you in the wrong direction. Their business models are incredibly different. The profit margins, sales numbers, etc. are going to be far different numbers. Selling coffee vs. selling cars are very different fields and shouldn’t be compared the same way.
This one is really easy. Enterprise value (EV) is the true value of a company. It is the market capitalization, with debt and cash included.
Market cap = share price x number of outstanding shares
Enterprise value = (Market cap + debt) – cash on hand
Enterprise value portrays what the company is worth if someone were to buy out the entire company. They take on the debt as part of the company, but cash is pocketed.
If a company has too much debt it isn’t a bad thing per say. As almost all high-growth companies have substantial debt because they are trying to grow their business at a faster rate. They have to take on loans to do so.
If a company thats been around for a long time has a lot of debt, then it may be a bad thing. Since, after all these years they still can’t shake of debt… thats a poor business.
Gross Profit Margin
(Total gross profit/total revenue)x100. This is one of my favorite numbers to look at because it shows if a company is growing faster than its competitor.
Take Zillow ($Z) vs. Redfin ($RDFN) for example.
- Zillow has a gross profit margin of 51%. (A reason I love this company)
- Redfin has a gross profit margin of 27%.
I own a lot of Zillow stock because they are an industry leader in real estate advertising growing 51% year over year. It’s rare to see industry leaders growing at that high of rates.
Enterprise Value/Gross Profit
Enterprise value/gross profit. This number determines how many dollars of enterprise value are made for every $1 dollar of profit. A lower number could indicate a more undervalued stock and vise versa.
Lets compare Nike ($NKE) vs Lululemon ($LULU)
- Nike has an EV/gross profit of 12.96
- Lululemon has an EV/gross profit of 15.62
In this case Nike is cheaper than Lululemon.
This is by far the best way to compare and evaluate companies/stocks. EBITDA stands for, earnings before interest, taxes, depreciation, and amortization.
EBITDA measures how well a company can generate raw income before they pay off debts. Comparing this number to another company tells who is better at producing income from the same business field. Once we take EBITDA and include the enterprise value, it takes into account the share price to see if a stock is “cheaper” than other.
- EBITDA= Operating income + Depreciation & Amortization. (The easiest way to calcualte when looking at a companies 10-Q on Bamsec)
Lets compare NVIDIA ($NVDA) vs. AMD ($AMD)
- NVIDIA has an EV/EBITDA of 62x
- AMD has an EV/EBITDA of 44x
A lower number could mean the company is “cheaper” than the other. (Remember other metrics must be taken into account too). This would make sense because NVIDIA just had a big run up over the last week. Makes sense it would be at an overvalued price right now.
Keep in mind that both these numbers are very high when compared to the overall market. The S&P 500 has an EV/EBITDA of 14x…The chip sector is a high growth industry, so the EV/EBITDA will be higher.
A good note to have as well is high-growth companies will often not display an EV/EBITDA. Or what they do show is not a good representation of the company as most of their profits are being reinvested into the company for faster growth.