The Motley Fool: Prices in perspective

Ask the Fool

Prices in perspective

Q: Would you please explain how a $20 stock can be viewed as more expensive than a $100 stock? – R.K., Lake City, Fla.

A: A stock’s price alone is far less meaningful than you think. You need to compare it to other measures, such as sales, earnings or cash flow, to be able to draw conclusions.

Imagine shares of two companies – Alpha and Omega – each trading for $36 per share. If Alpha’s earnings per share, or EPS, for the past 12 months is $2 and Omega’s is $3, then Alpha’s price-to-earnings ratio (representing price divided by EPS) is 18, while Omega’s is 12. You’d have to pay $18 for each dollar of Alpha’s earnings, versus just $12 for Omega’s. Already, Omega looks cheaper.

To get a sense of a company’s size, focus on its annual revenue or its market capitalization. Market cap is the current share price multiplied by the number of shares outstanding, reflecting the current total price tag the market is placing on a company. If Alpha sports 10 million shares and Omega has 1 billion, then Alpha’s market cap is $360 million and Omega’s is $36 billion. Despite the same stock price, Omega is a much bigger company.

When evaluating a company, look far beyond its price. Assess how rapidly it’s growing, how much cash and debt it has, what its competitive advantages and prospects are, and how undervalued or overvalued it appears to be.

Foolish Trivia

Name that company

I trace my roots back to 1901; my first product was saccharine. Decades later, I sported major agricultural, pharmaceutical, nutrition and chemical businesses. After mergers and reorganization, I am now an agricultural giant and the world’s largest seed company, with products that help farmers increase crop yields. Many don’t like my genetically modified seed business or my pesticides and herbicides. Based in St. Louis, I rake in more than $14 billion annually, employ more than 21,000 people worldwide and have 404 facilities in 66 countries. My CEO is Hugh Grant – but no, not that one. Who am I?

Last week’s trivia answer: ConocoPhillips

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