Explaining the PE Ratio
Revolutionizing the Movie Rental Business
Stock Market Analysis Video: Earnings Reactions
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Reaching into the mailbag this week, I found this reader question:
“Could you please explain PE ratios? After a recent purchase, I discovered the listed PE to be much higher than expected. My broker responded that the forward PE was in normal range and “don’t look in the rear view mirror.” Thank you for your help.”
Usually people are not alone in their desire to know things, so I decided to share the answer here.
If you divide a company’s stock price by its earnings per share, you’ll come up with a price/earnings ratio, or PE. This simple number reflects how well thought-of the stock is by investors. A single-digit PE is generally considered to be low, while a number over 20 is generally considered to be high. If stocks were commodities, like bananas, a low price/earnings ratio would represent a bargain--a good value.
But at Cabot, a high PE does not keep us from buying a strong growth stock because, unlike commodities, when you buy a stock you are betting that earnings will grow in the future. And a high PE simply confirms that other investors believe your company will experience fast earnings growth in the future.
Moving onto current stocks ...
There’s no doubt that Netflix (NFLX) has transformed, and continues to revolutionize, the movie rental business. Hundreds, perhaps even thousands, of Blockbusters and mom and pop video stores have shuttered their operations as Netflix became the undisputed king of the movie rental business.
The stock has appeared in numerous Cabot newsletters over the years, most recently in Cabot Stock of the Month Report in February. This is what Editor Timothy Lutts wrote about it there:
“What’s revolutionary about Netflix is its delivery methods. Back when everyone was accustomed to driving to the corner store to rent a video, Reed Hastings founded Netflix on the idea that using the U.S. Postal Service to deliver rented DVDs would be a superior business model. Critics scoffed, but Reed was right. Today, with more than 12.3 million subscribers, Netflix is the biggest company in the business. The old leader, Blockbuster (BBI) is shrinking ... and its stock sells for less than 40 cents.
“You may already know how Netflix works, but for the uninitiated, we’ll explain. Netflix’s simplest plan costs just $4.99 a month, and gets you the rental of two DVDs per month. The biggest plan costs $16.99 a month, and enables you to have three DVDs in your house at once, and to have them replaced as quickly as the postal service can ferry them back and forth ... very quickly, in our experience. Theoretically, accounting for normal postal service, you could watch roughly 30 movies a month that way. With two adult tickets at our local Loews cinema costing $21, we call that an incredible bargain, not least because Netflix pays all postage costs.
“But Reed is always looking ahead, so now, in addition to those discs the postman brings, the unlimited Netflix subscription enables you to instantly watch any movie you choose online, from your computer or television, at any time. Theoretically, you could watch these instant movies every waking hour of every day, for a whole month, for that $16.99. Happily for Netflix, it costs a lot less to deliver movies this way!”
And things just keep getting better for the company! This week, it reported stellar first quarter net income of $32.3 million, or 59 cents a share, up from $22.4 million, or 37 cents a share in the same period last year.
Netflix reported $493.7 million in revenue, a 25% jump from the year-ago quarter. The company ended the quarter with about 14 million subscribers, a 35% jump from the 10.3 million subscribers at the end of the first quarter of 2009.
And the stock reacted well to the earnings news, hitting an all-time high and crossing the 100 level for the first time ever. Tim’s Cabot Stock of the Month Report subscribers are up 56% since the stock was recommended.
Watch the video below to hear Mike Cintolo’s latest thinking on Netflix’s reaction to its earnings report.
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5 Stocks Wall Street Visionaries are Buying Now
Only one sector has the same potential that the Internet did in the 1990s ... and it’s starting to take off right now. Smart investors are already taking positions ... don’t miss this opportunity to profit from the next big thing.
Cabot Green Investor Editor Brendan Coffey has just released his newest Special Report, “5 Stocks Wall Street Visionaries are Buying Now,” to help you start profiting from the enormous opportunities in the Green sector today!
Now on to Cabot’s weekly Stock Market Analysis Video with Cabot Market Letter and Cabot Top Ten Report Editor Michael Cintolo. The market and leading stocks had another good week, but some there is some volatility under the surface because of earnings season.
Mike discusses what different earnings reaction scenarios mean for stocks and how reading a chart correctly can help you evaluate whether to sell, buy or hold.
Mike discusses Tupperware Brands (TUP), Tempur-Pedic (TPX), VMWare (VMW), F5 Networks (FFIV), Netflix (NFLX) and Cree (CREE).
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Timing is Everything
From the bear market bottom in 2003 to the bear market bottom in March 2009, subscribers to Cabot Market Letter made a stunning 94%. Compare that to the S&P, which LOST 18% over the same period!
Or consider just the past two years. Cabot Market Letter has beaten the market by 64%, according to Timer Digest, which just ranked Cabot Market Letter third among all long-term timers.
If you’re a Cabot Market Letter subscriber, this will not be surprising. You know how Michael Cintolo helps readers conserve cash when the market is unsupportive and to invest aggressively when the market trend is up. But if you’re not a subscriber yet, you owe it to yourself to take a look at the Cabot Market Letter.
In case you didn’t get a chance to read all the issues of Cabot Wealth Advisory this week and want to catch up on any investing and stock tips you might have missed, I have links below to each issue.
Cabot Wealth Advisory 4/19/10 - Looking Under the Hood of the iPad
On Monday, Brendan Coffey wrote about what’s in the iPad, most notably, the LEDs that make its screen so bright and battery life so long. Brendan discussed the growing LED market and a company that is essential for LED production. Featured stock: Veeco Instruments (VECO).
Cabot Wealth Advisory 4/20/10 - How to Plan for the Dividend Tax Increase
On Tuesday, we brought you an article from a guest editor, Carla Pasternak, Chief Investment Strategist of High-Yield Investing at StreetAuthority. She discussed coming changes in dividend tax laws and some investment options for tax-advantaged yields.
Cabot Wealth Advisory 4/22/10 - A Stock I Could Fall in Love With
On Thursday, Paul Goodwin wrote about why his love for Apple, the company, stops him from investing in AAPL, the stock. He also wrote about the vibrant life and lessons taught by infamous investor Jesse Livermore. Paul finished by discussing why it’s important to cut your losses short. Featured stock: Longtop Financial Technologies (LFT).
Until next time,
Editor of Cabot Wealth Advisory