Valuation Misconceptions: Amazon's High PE Explained

3 months ago

"The first one, which might be a controversial one, might surprise some of you, is that the PE is useless. So, back when I started investing, and maybe some of you are the same, you go on Yahoo Finance and you see a company trading at 30p or 35p. Oh, that's overvalued. Would you skip the stock? 25p is too high. Would you skip it? 50p is too high. 100 PE is too high. All of it is too high. It's overvalued. Would you skip the stock? I used to do the same thing. But as you go along, you're going to learn that the PE is useless for three main reasons. The first reason is some companies have a high PE on purpose because they reinvest in themselves. You could say companies like Amazon, this is the best example I can come up with because Amazon has $311 billion in gross profit, spent 88 billion on research and development, and its net income is around $59 billion. Now, Amazon has Amazon.com, it's going to be here forever, pretty much. Yet, they're spending 88 billion in R&D. So instead of spending 88 billion, let's say next year they decided to spend 42 billion or $44 billion. In this case, net income would jump from 59 billion to around a hundred billion, and the PE that looks like 35 could fall to maybe 22 to 25."

The speaker challenges the conventional reliance on the PE ratio as a valuation metric by using Amazon as an example. He explains that a high PE can be justified when a company reinvests heavily in growth, such as R&D spending. This reinvestment temporarily lowers net income and inflates the PE, suggesting that investors should look deeper into the company's fundamentals rather than skipping a stock solely based on a high PE number.

Related Stocks