Dealmaker’s Diary: Don’t Let This Common Metric Cost You Money

Alpesh Patel|February 6, 2025

Does JPMorgan’s low P/E ratio make it a better buy than Microsoft?

Not knowing that answer keeps many investors from capturing the market’s biggest gains…

Microsoft trades at 33x earnings while JPMorgan sits at just 13x. Value investors would say JPMorgan is the obvious choice. But they’re missing something crucial.

Look at Nvidia… trading at 48x earnings, yet it’s been one of the market’s best performers.

Here’s the thing…

Focusing only on P/E ratios could leave you watching from the sidelines as the market’s biggest winners soar past.

Tune in to today’s Dealmaker’s Diary to see what really drives stock returns. Don’t miss these critical insights… NOW.

This the kind of research my clients pay thousands for… but you get it for FREE as a Total Wealth subscriber.

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TRANSCRIPT

Valuations are often misunderstood in their importance to future stock price movements. Academic research has examined this extensively. There are many ways to measure company value. Value, unlike growth, is conceptually more complex. Growth is straightforward: if profits, sales or cash flow increase year over year, that’s growth.

But what is valuation?

Consider buying a property that pays $1,000 in annual rent. If someone offers to buy it for $100,000, you’d accept immediately. You’re only getting $1,000 yearly in rent, and they’re willing to pay $100,000 – they’ve overpaid.

If they instead offered $500, you’d decline. You earn $1,000 yearly in rent, so they’ve undervalued it. You’d eagerly purchase that property at $500 because you know you could sell it for more later.

The price they’re willing to pay is the price; the earnings you’re getting are the earnings. That’s what valuation measures. There are many valuation measures at the economic level: the Shiller PE or CAPE ratio, the PEG ratio (which incorporates growth), relative PE compared to market and peers, forward PEs, and trailing PEs.

None of these measures gives the complete picture. At the time of recording, the S&P 500 shows you’re paying $33 for every dollar of future profits in Microsoft and $48 for every future dollar of profits in Nvidia.

But you’re only paying $13 for every future dollar in JPMorgan. Why doesn’t everyone invest in JPMorgan since it’s cheaper?

Looking at which stocks have performed well, this pattern has remained similar for over a year. The highest-valued stocks have been the best performers. How can this be if they’re overvalued?

Some value investors say they’ll wait for a crash but end up missing opportunities because they focus too heavily on valuation. All future judgments should consider two factors: what’s important and how important it is.

Valuation is one factor, but if you overemphasize it while ignoring growth, dividend income, cash flow and momentum – which hedge funds successfully focus on – you’ll miss the bigger picture. Microsoft might be worth $33 for each dollar of profit because its growth expectations exceed JPMorgan’s.

Higher price-earnings ratios can indicate greater growth potential. Consider a rental property earning $1,000 annually that doubles each year. Suddenly, paying $100,000 makes sense as the rent will increase from $1,000 to $2,000 to $4,000 to $8,000 to $16,000 to $32,000 to $64,000 to $128,000 to $512,000 to $1,024,000. The growth rate suggests it’s a bargain.

Higher PEs aren’t necessarily negative. Valuation alone shouldn’t determine investment decisions.