No one wants to overpay for a stock. And with stocks at all-time highs, many investors are concerned about stock valuations. In this clip from Motley Fool Live, recorded on June 30, Motley Fool contributors Jon Quast and Brian Withers along with longtime Fool Anand Chokkevalu tackle this valuation issue by giving three tips.
Jon Quast: For me, with valuations, this is how I think about it. What is a reasonable valuation? It's hard to say. It's just completely relative. What I like to do, though, to take the relativity out of it, is look over five-year averages, 10-year averages, things like that. For example, a company like Starbucks, zoom out on the P/E ratio, for example. Where does this stock normally trade? If all of a sudden it's normally trading at 30 times earnings, and now it's at 60 times earnings, that's a little bit of a valuation concern for me. It's not so much the number, it's where it's at relative to where its historical average is.
Brian Withers: Yeah, I'll tag onto that a little bit, Jon, too. We were looking at Intuit (NASDAQ:INTU), actually. We did a deep dive with Intuit on Tuesday, and it has been a tremendous market-beater over the years. And its valuation has gradually crept up over time. I think, what the market is doing is seeing that Intuit is a much more capable company, much more resilient, and is valuing it more as a higher quality.
I think to your point, quick changes in relative valuation are something to watch. But maybe creeping up over time is just a sign that the company is being valued by the market better.
Anand, were you going to tag onto this one?
Anand Chokkavelu: Yeah, I can talk to that. Specifically for me, Airbnb (NASDAQ:ABNB) currently is a little under $100 billion in market cap. When I bought, it was around when Jon bought it. It was probably assuming share count similar, it was above $100 billion. For me, the smaller the market cap and the higher the growth rate, the less I care about valuation. If you've got a $500 million company that has a lot of optionality and prospects for growth, I'm not going to care whatever price-to-sales ratio or whatever you throw at me, probably doesn't have earnings, because it's got so much growth potential ahead of it that it can 10-bag almost no matter what valuation you give that at that low of a market cap. But at $100 billion market cap, you got to do a lot to get to $1 trillion in market cap, which only the FAMGA stocks are at now. That's tough. Airbnb has to be in the same league if it were to happen immediately, same league as Facebook, which just got there now. Then that's a tougher thing. Then you're weighing that against the downside risk. That's what I mean when valuation concerns me.