When ‘Cheap’ Assets are a Mirage

This post When ‘Cheap’ Assets are a Mirage appeared first on Daily Reckoning.

A friend recently pitched me on his favorite cryptocurrency, XRP.

The core of his thesis was that since XRP trades at just $1.41 per token, it’s a bargain compared to Bitcoin.

Bitcoin trades at $78,600 per coin. So he believed that XRP is wildly underpriced at just $1.41. He told me that buying XRP today is like buying Bitcoin in 2012.

My friend doesn’t have a lot of investing experience, so I explained a key concept to him.

I told him the price of any stock or crypto is meaningless. UNLESS you know how many shares or tokens are out there.

There will eventually be 100 billion XRP tokens circulating in the world. Multiply that by the price of $1.41, and you get $141 billion. That’s the total market capitalization of XRP.

Meanwhile, there will only ever be 21 million Bitcoins in the world. Multiply that by the current price of $78,600 and you get a market capitalization of $1.65 trillion.

On price alone, it appears that Bitcoin is 55,000x more expensive than XRP ($78,600 vs $1.41). But once we factor in the enormous amount of XRP (100 billion tokens), it changes everything.

In reality, Bitcoin is only 11.6x bigger than XRP by market cap (total value).

So no, XRP is not some tiny crypto project which people are getting into early. It is massive. And probably still overpriced (sorry XRP bros).

Stocks Too

The same concepts apply to stocks. Just because a company’s shares trade at $3 doesn’t mean it’s cheap.

Let’s look at two stocks with wildly different prices, but similar valuations (market caps).

Ambev (NYSE: ABEV) is a Brazilian beer company. It trades at “just” $3. But there are 15.5 billion shares outstanding. So its market cap is about $48 billion.

Autozone (NYSE: AZO) is a well-known auto parts retailer and distributor. Its shares trade at $2,902. But there are only 16.3 million shares outstanding. Autozone’s market cap is also $48 billion.

These two stocks trade at wildly different prices ($3 vs $2,902). But investors value them the same ($48B market cap).

All because of a different number of shares outstanding.

We should never buy stocks, or any other investment, simply due to the fact that the price-per-unit is low.

A $1 stock can still be incredibly expensive.

I’ve also had people tell me they would rather own 100 shares of a $1 stock than 1 share of a $100 stock. But if the company does well, it won’t matter.

If it goes up 20%, the gain will be the same either way. You end up with 1 share worth $120, or 120 shares worth $1 each. Same result, a $20 gain on your $100 investment.

Focus on Fundamentals

So we know that the price of an asset tells us nothing by itself.

Much more important are the fundamentals.

We can only judge how cheap or expensive a stock is by looking at its key stats.

• What’s the price/earning (P/E) ratio? Lower is cheaper.
• How does free cash flow look?
• How fast is revenue growing? Earnings?
• What’s the dividend yield?
• Is the dividend sustainable?
• Are there balance sheet problems? Too much debt?
• Is leadership stable? Are they hitting goals?
• What’s the competitive situation? Are they disrupting, being disrupted, or coasting?

We’ll dig further into fundamental analysis soon.

For now, I wanted to clear up this misunderstanding about price vs market cap.

Chasing low-priced stocks is a common error. Don’t get me wrong, occasionally it works. But price should never be what draws us to a stock.

Growth, earnings, yield. That’s what should draw us to a stock. Not a discounted share price.

The post When ‘Cheap’ Assets are a Mirage appeared first on Daily Reckoning.

This story originally appeared in the Daily Reckoning . The Daily Reckoning, offers a uniquely refreshing, perspective on the global economy, investing, gold, stocks and today’s markets. Its been called “the most entertaining read of the day.

Source: https://dailyreckoning.com/when-cheap-assets-are-a-mirage/