What's an expensive stock

A few months ago I was listening to the radio and a person was commenting on the value of Tesla stock. They said something very interesting that Tesla was worth more than x amount of Ford stock and y times more than General Motors but only had sales of z amount. They thought Tesla was extremely overvalued because of their stock price. This is not the case that price does not make a stock expensive or cheap. The price of the stock has to do with the amount of shares outstanding, earnings per share, and how many people want to buy/sell that stock.

Back to the Tesla example, the reporter did not know anything about stocks or he never would have said such a stupid comment. Tesla is worth today at the end of trading $19.8 billion, has 122.6 million shares outstanding, and is trading at $162. Ford on the other hand is trading at $16.45 much less than Tesla's share price but Ford is worth $64.7 billion and has 3.9 billion shares. So see all those numbers are different and that is why evaluating a share on its share price is not smart. Each stock has its own number and makes for an inconsistent comparison.

There is a better choice to value a stock that is consistent across companies or at least more consistent. It is by no means a perfect fit because there are many different techniques. The most commonly accepted is the Price to Earnings ratio (P/E ratio). This takes the company's stock price and divides it by the company's current earnings. This puts it in a number that means the same thing for each company. When looking at our example again Tesla's P/E ratio is nonexistent because they lost money in the last year while Ford on the other hand is trading at a P/E ratio of 11.6. Now when we compare the value of the two stocks we see a huge difference and can make comparisons that make sense. Ford is trading at a reasonable valuation and Tesla is trading on possible future growth. Tesla is an expensive stock because it did not make money last year. That might change this quarter or the next.

The poor reporter might have meant that Tesla stock was being trading on speculation and had a much higher valuation than Ford and General Motors. But in his reporting he specifically mentioned share price and compared it as such. Let's try and be smart traders and end this financial illiteracy. Make sure you don't get sucked into a stock just because it is cheap in share price. The valuation could still be way above what is normal or a cheap valuation. Price should have nothing to do with decision making on investing in a company unless price is compared to some other number in the company's financial report.