Ep 706 | The P/E Ratio Rule: Your First Investing Edge

Thank you for joining me today. It's Brian Gubernick, and welcome to the No Days Off podcast, where we believe that every single day brings a new opportunity to get better. We are going to talk a little bit about stock investing today, and today's topic— when I was originally kind of putting this content together, what what I was actually attempting to do was teach my daughter Avery, who just recently turned 15 and is showing some interest in the stock market. I was trying to teach her some basic, you know, first in sort of knowledge around stock market investing, things that she could understand and leverage as she starts messing around with the stock market and figuring out how it all works. And I thought, you know, teaching her that it might be valid, valuable to share the same message, maybe not constructed for a 15-year-old, uh, but the same message for our No Days Off Nation here today. Now, when you think about kids, or my daughter in this particular case as a 15-year-old, they have a tendency to think about the stock market as a giant casino. They hear about these quick wins and social media hype and and all of that. But the, the very first lesson in the No Days Off philosophy of, of stock market investing is that investing is not gambling. It is not gambling. It is about becoming a part owner of a business that you believe will make more money 10 years from now than it does today. Stocks are ownership. When you buy a share, you own a tiny fraction of the business. And recognize your greatest asset is time. So for my kid at 15, she has decades for that money to grow through compounding. That's the big— the big advantage that she has over most every other investor out there. So I'm walking her through these steps, and I told her, hey, step 1 is only invest in what you understand. Forget about the complex industries. Forget about the random companies and the TikTok, you know, companies that are shared. I think the fundamental rule of great investors like Warren Buffett, no surprise, is to start with what you know. I said to Avery, what apps do you use every day? What streaming services can you not live without? What shoes or brands do you and, and your friends wear? The companies that dominate your life, her life, likely dominate the market. So your job is to move from being a customer though to being an owner. So as you're thinking about what it looks like to be an owner, I think next what we need to talk about is what you should be studying, what should you understand. I think there's two metrics that matter most. When you look up a stock ticker, you see, like, if you type in any stock ticker, you'll see a million numbers. You only need really to focus on two simple concepts to start. Number one, understand the company's total value. That's its market cap. Think of market capitalization as the sticker price to buy the entire business. If you don't know how to calculate market cap, it's simple. It's the share price multiplied by the total number of shares that are outstanding. So you take the price of the share that day and multiply it by all of the shares that are currently outstanding that are trading. You can Google or chat or find this information pretty much anywhere in seconds, and it matters. Why does it matter? Because it tells you how big the company is. If the company is worth a few billion dollars, then it's small. It's a small-cap investment, and that means it's riskier. If a company's worth a trillion dollars, that means it's massive and it's much more stable. So typically you need to stick to companies you know, and they are usually large, stable businesses. Now, the next thing I told her in terms of metrics— I mentioned there's two. Market cap. The second is the price-to-earnings ratio. The price-to-earnings ratio. And this is the price tag on the company's earnings. I think it's the single most important tool for any beginner to understand, because what it answers is this rather simple question: how much are you paying for every dollar the company earns? How much are you paying for every dollar the company earns? So the formula here for the PE ratio, for the price-to-earnings ratio is to take the stock price and divide it by the earnings per share. Again, information that you could find in seconds with a search. The stock price divided by the earnings per share, that is your price-to-earnings ratio. A simple read of this, if the stock has a PE of 20, it means that investors are willing to pay $20 for every $1 of annual profit the company makes. Makes sense? So the insight here, you can use this for comparison. If your favorite fast food company has a PE of 30 but its main competitor has a PE of 15, then you have to ask the question, why is the market willing to pay twice as much for the first company's profits? It's either expensive, in other words, it's overvalued, or the market expects it to grow a lot and grow much faster than other stocks. So you've got to dig deeper before you buy the expensive one. So I want her to understand the PE ratio. Now, the numbers here give you facts, but you actually have to read the story to find the quality of that company. Warren Buffett would teach us to ask for the economic moat. The economic moat. A moat is a wide protective ditch around a castle. So what is the business's economic moat? What is its protection? Is it an incredibly strong brand like Nike? Is it a patent? Or is it simply too expensive for a new company to compete? Like a company that requires massive factories or something like that. See, this wide moat keeps competitors out and it ensures longer-term profits. So, I wanted to ask, you know, what's the economic mode of this company? I also wanted to look for consistency. Do the company's profits go up every year or are they constantly bouncing around? See, consistent upward growth is the hallmark of a disciplined, well-run business. So, really basic information around stock market investing. Again, understanding how large of a company you're working with and understanding its price-to-earnings ratio, and then digging deeper into its story and specifically its economic moat, as well as its, its performance— is it consistent or inconsistent? These are really, really basic things that we all should be doing, not just my 15-year-old daughter, but we all should be doing instead of just looking at stock prices. Stock prices are a daily distraction. So stop looking at them. The action that I might give you today, if you want to go through an exercise, is pick 3 companies. Choose 3 public companies that you interact with every week and then go find the data. Look up the market cap and the PE ratio for all 3, and then go find the story on each of them. Research one fact about their economic moat. And, and, and compare and contrast. See what you learn about those 3 companies, their data, and their story. I think this is about commitment to being a disciplined owner and not just this frantic day trader. And I think the discipline you learn at an age like my daughter's is gonna, is gonna make for success down the road. But we're never too late. We're never too late. So if we're gonna talk stock investing, let's talk about these basic understandings, these, these basic metrics, and then let's build from there. That's all I have for you today, the No Days Off Podcast. Thank you so much for listening, and remember, every single day brings a new opportunity to get better. So let's get after it.