Warren Buffett, often called “The Oracle of Omaha,” is a legendary figure in the world of investing. He amassed his $140 billion fortune by buying his first stock at age 11 and his first real estate investment at age 14. After college, he established Buffett Partnership Ltd. in 1956, and alongside the late Charlie Munger, acquired a textile manufacturing company named Berkshire Hathaway.
Today, Berkshire Hathaway (ticker: BRK.A, BRK.B) is a diversified holding company and is the world’s most expensive stock, with a single Class A share priced at about $686,000.
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The next priciest stock is NVR Inc. (NVR), a Virginia-based home construction company priced at close to $9,800 per share.
What does the price of a stock tell us? Consider the following to learn more about stock pricing:
— Is an expensive stock a good buy?
— Why do stock prices fluctuate?
— Key financial indicators for investors.
— Alternative ways to purchase stocks.
— Is a high price a warning signal?
— Dinner party conversation.
Is an Expensive Stock a Good Buy?
Buffett would be the first to say that it is impossible to know how well any stock will ultimately perform. Influenced by Benjamin Graham’s principles of value investing, Buffett focuses on finding quality companies trading below their intrinsic values.
Buffett would also tell you that the stock price reveals very little about the company’s actual value; rather, it best reflects the company’s ownership structure.
Part of Berkshire’s long-favored method of returning money to its shareholders is to buy its own stock back. In doing so, the number of outstanding shares decreases, which increases their price per share. Since 2018, Buffett has authorized over $77 billion in Class B share buybacks, with $356 million authorized through Q2 2024.
To gain insight and clarity, a potential investor must consider a stock’s earnings, assets and growth potential. The stock is only worth its price if the price is low in comparison to these indicators.
Why Do Stock Prices Fluctuate?
Share prices change on a daily basis under the principle of supply and demand. A share price increases when demand is high and falls when demand is low. Demand is impacted by multiple factors, including many that are not controllable by the issuing company itself:
— Company performance: Strong earnings will increase demand, while poor results will depress the price.
— Economic conditions: Demand rises when an economy is strong and healthy, and contracts when recession or other economic slowdown fears are imminent.
— Investor sentiment: Prices rise when the public is confident that they are safe, secure and economically capable of living their desired life. Sentiment is not always driven by fact; rather, it is the public’s perception of events that has the greatest impact on prices.
Key Financial Indicators for Investors
Four different metrics are invaluable for investors looking into a company’s health and investment potential:
— Market capitalization: The total value of a company’s outstanding shares, calculated by multiplying the current share price by the number of shares. It helps compare company size and market performance against peers.
— Price-to-earnings ratio (P/E): Measures if a stock is over- or under-valued by dividing the share price by the company’s earnings. Investor sentiment has a deep bearing on the P/E ratio. When investors are excited over a company’s announcement or an economic trend that bodes well for the company, both the stock price and the P/E ratio will increase. Conversely, consumer pessimism will cause both to fall. It can be either trailing (based on past earnings) or forward (based on forecasted earnings). P/E ratios are favored by analysts because they create an easy apples-to-apples comparison between similar stocks.
— Price/earnings-to-growth ratio (PEG): Indicates future earnings growth by dividing the P/E ratio by the earnings growth rate. Fast-growing companies usually have higher PEG ratios than slower-growing ones.
— Enterprise value-to-EBITDA ratio (EV/EBITDA): A popular alternative to P/E ratios, particularly for startups or rapidly growing companies. It is calculated by dividing enterprise value by EBITDA (earnings before interest, taxes, depreciation, and amortization).
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Alternative Ways to Purchase Stocks
Even if an investor has made all the appropriate calculations, the most expensive stocks may still deter adding them to their portfolio. Smaller investors may not be able to afford a complete share. Fortunately, there are three additional opportunities to own stocks if their fundamentals are sound:
— Exchange-traded funds (ETFs) are a basket of stocks, bonds and many other types of investments. While the investor doesn’t own the underlying assets, an ETF enables them to easily trade and diversify holdings, often with lower fees.
— Fractional shares are investments made on the basis of a specific dollar amount instead of the individual share price.
— Options trading is a method that captures value by actively investing in the direction the stock moves, rather than the increase/decrease in value of an individual stock.
These opportunities allow an investor to participate in stocks, but they do not carry all the benefits associated with stock ownership, such as voting rights.
Is a High Price a Warning Signal?
High prices may give the impression that there is limited upside potential. Again, without making the appropriate calculations, it is not possible to answer this question fully.
Remember, the stock price is just one factor to determine if an investment is an attractive opportunity or even a flashing yellow light. The old adage, “buy low, sell high” comes from the expectation that a stock will appreciate. But, what should an investor do when they run the numbers and the stock is overvalued?
Overvaluation occurs when a stock becomes detached from its intrinsic value. This often occurred during the COVID-19 pandemic when companies like Peloton Interactive Inc. (PTON) and Zoom Video Communications Inc. (ZM) surged in popularity but saw demand wane as the economy reopened.
Amazon.com Inc. (AMZN) is currently considered the most overvalued stock. With a market capitalization of $1.94 trillion, the stock closed at $187.97 per share on Sept. 27. Analysts have calculated that a fair price would be $103.01. For this perennial favorite, competition has been increasing in all its key segments: e-commerce, subscription-based shipping, streaming services and cloud computing. Tesla Inc. (TSLA) is another company where competition is heavily impacting corporate performance. However, both companies have traditionally responded well when new entrants to their markets appear.
Since most stocks will ultimately realign with their fundamentals, an overvalued stock will likely underperform the market in the short term, but it can also become an attractive buy after adjusting its strategy.
Dinner Party Conversation
People love to gather over a meal. When the talk turns to investments, a high stock price might impress some people.
But true investment savvy shines forth from understanding a stock’s fundamentals, history and momentum. As Warren Buffett has often said, “Time, not timing, is the key to building wealth.”
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What Is the Most Expensive Stock? originally appeared on usnews.com
