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Week of December 13th, 2022 - Price to Earnings Ratio, Remote Work, Wholesale Prices Rise
Topic Breakdown - Price to Earnings Ratio
The ratio for evaluating a firm that compares its current share price to its earnings per share is called the price-to-earnings ratio. So what does this really mean? A stock's P/E ratio is calculated by dividing its price per share of its stock by the yearly income the company earns per share. A stock has a P/E of 10 ($10 / $1) if its share price is $10 and its profits per share are $1. Basically, the price-to-earnings ratio, which compares a company's current share price to its per-share profits, is used to determine the company's value.
So how do we determine the value of a company using the price-to-earnings ratio and find out what other investors think? Well, it’s pretty simple! Let’s say a company earns $5 per share, and the share price is at $10, but a different stock is trading at $20 with the same $5 per share earnings. This means the first company/stock has a P/E ratio of 2 ($10/$5), while the second stock has a P/E ratio of $4 ($20/$5). The second stock has a higher P/E ratio. Although they are making the same earnings as the first stock, investors are willing to buy the second stock at a higher price, driving the stock price higher. This can tell us that other investors may think that this stock will do well or that this company will increase earnings later-on since they are willing to pay more for a stock that has the same earnings as a lower-valued stock. In general, firms with a high P/E indicate that investors anticipate greater future profit growth than those with a low P/E. A low P/E ratio might mean that a stock is currently undervalued.
While P/E ratios are definitely important to look at, there are also other factors we need to consider, as P/E ratios have their limitations. When comparing various firms, one major drawback of utilizing P/E ratios is that, due to the various ways that organizations generate revenue, valuations and growth rates of corporations can sometimes range drastically between industries. Because of this, P/E ratios should only be used as a comparing tool when thinking about businesses in the same industry because only this sort of comparison will result in accurate valuations. Essentially, don't compare a tech company's P/E to that of a healthcare company.
Remote Work Is Permanent, Economists Say
During the pandemic, there was a surge of companies that declared a remote working environment, however, it has now become a fixture in the U.S. job market. According to a report, nearly 10% of online job searches in September included the keyword “remote work”, which is close to a sixfold increase relative to September 2019, prior to the pandemic. Another reason for remote work still being in practice is due to employers, themselves. They are constantly advertising work-from-home job opportunities, with 9% of job openings doing so, threefold over the same time period. At the peak of the pandemic, more than 60% of total workdays were done at home, mainly because of stay-at-home orders issued by the government This percentage has declined to 29.4%, but financial researchers and economists expect this decline to stall.
According to an economist at Stanford, “The pandemic has started a revolution in how we work, and our research shows working from home can make firms more productive and employees happier. But like all revolutions, this is difficult to navigate”. The benefits of working from home typically result in higher productive work time. It saves employees on average 70 minutes a day of commuting and close to half of that time is spent on working, resulting in benefits for both the employee and the company. Overall, remote work has contributed to approximately 4% more work hours during a 40-hour week.
Wholesale Prices Rise Higher Than Expected, Despite Inflation Slowing Down
In November, wholesale prices rose more than expected with food prices significantly increasing, crushing hopes of inflation levels dropping, reported by the Labor Department. The producer price index, a measure of what companies review for thor products in the pipeline, showed an increase of 0.3% for the month and a 7.4% increase from a year ago, both of which were the slowest 12-month pace since May 2021. Additionally, stocks fell following the labor report following numerous reports and indications of a positive open on Wall Street, with treasury yields continuing to reap high returns. Markets will now have to shift their focus to the consumer price index, which will come out on Tuesday morning.
The high levels of inflation indicate that the Fed is on pace for another interest rate hike of 0.5% that would push back benchmark borrowing rates to a new target range of 4.25%-4.5%. Furthermore, policymakers have been pushing for higher interest rates to combat stubborn inflation. According to the chief economist at LPL Financial, Jeffery Roach, “The monthly increase in producer prices illustrates the need for continued tightening, albeit at a slower pace. The inflation pipeline is clearing and consumer prices will slowly move closer to the Fed’s long-run target”. This was the third consecutive month that the producer price index increased by 0.3% but it came with a decline in final demand energy costs.
“The secret to wealth is simple: Find a way to do more for others than anyone else does. Become more valuable. Do more. Give more. Be more. Serve more.” ― Tony Robbins, Money Master the Game: 7 Simple Steps to Financial Freedom
To become successful, you need to set yourself apart from others. It isn’t enough to simply do what others do; rather, the key to success lies in doing more than others to set yourself apart from the crowd.
Term of the Week
ROI: Return on investment, or ROI, is a measure of the profitability of an investment. The profit minus cost is divided by the total investment. ROI is a common indicator of profitability and success and can act as a benchmark for future investment decisions.