Plus: why Netflix makes a bullish case for tech
 
   
     
   
 
OCTOBER 18, 2024
   

Hey y’all,

Happy Friday! 

There’s one kind of “old school” stock fundamental that I can’t help but pay a lot of attention to: P/E Ratio.

Now, I know P/E Ratio isn’t without its critics. And it certainly isn’t without flaws.

I would never use it in a vacuum. And I don’t necessarily think it’s the best evaluator on a case-by-case basis: i.e., if NVDA’s P/E ratio is 64 and CHWY’s is 34, that doesn’t mean CHWY is automatically the better stock to own.

However, on a broad scale, I do think P/E can tell us something about the health of companies. 

And while all of us trading junkies might put a lot of other things first, we need to occasionally step back and remember that much of the stock market is made up of retail investors trying to buy shares of healthy companies.

And that’s why this chart caught my attention when Graham Lindman shared it in our company Slack chat earlier this week:
 
 
What that chart shows us is that, since 2021, even while stocks have climbed 38%, their P/E ratios have dropped 19%! 

Now, remember: the price of a stock is half of the P/E equation. It’s the numerator in that fraction (unless it’s the denominator. Sorry, Mr. Kohrer, don’t hate me for forgetting! — it’s the top one, is my point!)

So you would think that P/E ratios would automatically be swelling higher if stock prices are growing substantially.

But that isn’t the case right now. 

Even as stock prices soar, P/E ratios are not keeping up — in some cases, they’re even dropping! 

Meaning that companies are better values to own NOW than they were three years ago, despite some pretty fast and furious growth in the stock.

One example of this comes on a stock we saw shoot higher on earnings this morning: NFLX.

Take a trip back with me to 2021. Joe Biden has just been inaugurated President, Tom Brady is still playing football, and you can’t turn on a radio station without hearing Olivia Rodrigo sing “Drivers License.”

Back then, we were in what I think of as the “Work from Home” (WFH) Bubble. We saw a ton of companies that were short-term darlings from the pandemic soar to astronomical P/E ratios. 

Basically, in the wake of COVID-19, any company that could help you enjoy life without coming into contact with other human beings was seeing tons of money flow in from Wall Street. And Netflix (NFLX) was a prime beneficiary. 

In 2021, NFLX had a P/E ratio as high as 95 — which most people would consider insanely high. And many rightfully did at the time.

Fast forward to the end of the year, and the “bubble” had popped, seeing companies like NFLX, ZM, DOCU, etc. bleed out aggressively all year long. 

Now, take a look at this chart and what’s happened since then. There’s a lot going on, I admit, but I’ll walk you through it.
 
 
Since the start of 2022, NFLX’s stock has climbed about 350% (that’s the green arrow at the top)...

Meanwhile, the blue line underneath, that’s the P/E ratio. Sure, it’s gotten higher since NFLX’s price bottomed out late in 2021. But it has not nearly kept pace with the price.

And, in the two years since, NFLX has had a series of mostly positive earnings reports. Good fuel for the fire of driving the stock higher.

I think this is a significant trend. Especially as interest rates get cut, we’re going to see even more money flow OUT of money market accounts and into the stock market, looking for “safe” stocks to buy. 

Now, Netflix might not spring to mind when you think of stable investment stocks, and its lack of a dividend hurts it in that capacity.

But the general idea, that companies are getting more valuable to own even as stock prices climb higher, is pretty significant.

P/E ratio might not be the end all, be all, but I think it’s painting us a pretty clear picture that the market is extremely healthy right now, no matter what the talking heads might say.

Remember: as Jack Carter pointed out to me yesterday at his 3pm briefing, the stock market is NOT the economy. Even if things in the economy are rocky, that doesn’t mean the market is heading lower! 

So I wouldn’t be too concerned about a bearish turn right now. We might see a small correction at some point, but that will just  be another opportunity for more money to pile in.

Oh, and by the way: if you missed Jack’s briefing yesterday, it was GREAT, and he did it again today, so make sure to grab the replay here.

To your prosperity,

Stephen Ground
Editor-in-Chief, ProsperityPub