Amazon and Facebook: Earnings

We once again find ourselves in "Bubble" Range. In the past few days Amazon came out with great earnings (at least great growth) as did Facebook. They put the stock's P/E ratio at 500 times earnings and 90 times earnings, respectively. I'll discuss the importance of this in a moment. The P/E ratio is a formula, Dividing the price of the stock with the EPS, or earnings per share. It is a way of measuring the health of a company. It doesn't matter if the stock is $5 or $500, this ratio shows what each share is making, expressed as a ratio that makes sense to people who follow such things.

But, I'm a former cabdriver and usually view the stock market from that perspective—no, not only the "meter drop," but hopefully using my experiences there to make common sense out of the big words, and the so-called big ideas.

So here goes: The P/E ratio shows how much money you pay in buying the stock to get at one dollar of earnings. This is really important. Think it through. If you were going to buy a business, for say $100,000, wouldn't you like to know what you money will make you?

For example, with Amazon (AMZN), the stock went from $602 yesterday to $660 today. This puts the P/E at around 500. This means that you are paying $500 to get at $1 of earnings. This is usually stated as a whole year. Would you give your money to a bank for a year to get $1 of interest?

With  Facebook, the stock went from the low $100 range and went up to $116. That puts the P/E around 90, or 90 times earnings. You're paying $90 to get at one dollar of earnings. Now, to be sure, P/E is an important barometer, but it is only one. This could be the greatest stock In the world—and many analysts think it is—but it is trading at high multiples.

The market reacts to this news. Indeed, it usually overacts. Many times, these stocks shoot up, but then back off, returning to the norm. Sometimes this is the normal range for this stock, sometimes it's a normal range for the market or sector.

The market norms right now are around 20 times earnings. One can find numerous stocks in the 8 X earnings, to 15 times earnings.

So, how do you play this? I'm not going to say. That is between you and your professional advisor, but I will give you somethings to think about.

Let's speak to the Facebook P/E. This 90 times earnings is high—hIgh for this stock, high for this sector. So, is it a good deal? Well, the answer is wrapped up in the future. The stock will move up, down or sideways.

Here is the bottom-line strategy for the stock: Everything returns to the norm, meaning normal. The P/E will come into line. So, one of two things must happen: 1. The stock price has to come down; or 2. The earnings have to go up. Notice these two items are the two sides of the formula: The Price and the Earnings. Change one and the division of Price over Earnings changes.

Remember:  "A Stock Price Today is Based on the Anticipation of Future Earnings." What are the company, the news pundits and the like saying about the future of these two companies? Notice this statement doesn't say Earnings, but The Anticipation of Future Earnings. When we buy a stock, we're buying the future of the stock. The past is an indicator, but ownership has its privileges, from here on.

I will weigh in now with my opinion: First Facebook: They are solid, and growing. And right now this means their earnings are growing. They will do well, but their stock will be volatile. This means different things to different people, but in short, these movements will give investors and traders, ample opportunities to get in and out.

Amazon for years has traded short-term profits for growth. They continue to do so. There are trades to be made, but I'd rather trade in other stocks, like Facebook, Netflix (NFLX), and several others.

Right now at 500 times earnings, it's a little to steep for me.

I will continue to watch these two and a host of other trend-setters.


Stock MarketWade Cook