This is not about unpunished “insider trading”, “fake transactions”, or “pump and dump” price manipulation that happens in every stock exchange. This is about what should be included in the as yet unwritten book Everything You Know About the Stock Market Is Wrong.
One definition of the word “rule” is, “One of a set of explicit or understood principles governing conduct within a particular activity or sphere.” For example, the law of gravity says: “A particle attracts every other particle using a force that is directly proportional to the product of their masses and inversely proportional to the square of the distance between their centers.” The rule from that “law” becomes “what goes up, must come down”. We might say that about an individual stock price but we also know that is not always true or at least not true for a very long time.
We explain that fact by saying that the limited numbers of exceptions actually prove the rule is true for at least the majority of cases. But we want the rule to be true and, therefore, try to ignore the exceptions or consider that these are one-off and totally unusual.
When it comes to the stock market—and because the modern stock market has been around for more than a century—we think that “as it was in the beginning is now and ever shall be”. But this is 2017 and it is not your great grandfather’s stock market. In fact, it is not even your older brother’s stock market from 10 years ago.
Forget about the fact that when I started trading the market professionally some 40 years ago, a client did not have a guaranteed confirmation of a trade until three or four days later when the paperwork came in the mail. The fact that confirmation of transactions is virtually instantaneous today is not the difference from way back then.
Maybe the best example of how the stock-market rules have changed is to compare to retailing giants Amazon and WalMart, which also happen to be two of the largest companies in the world. Amazon is the fourth largest in terms of stock-market capitalization or- worth. Wal-Mart is the largest in terms of revenue.
Wal-Mart went public and started trading in 1972; Amazon was listed in 1997. You might think these two huge household name companies might share some stock market similarities. Nothing could be farther from the truth as they follow different “rules”.
Wal-Mart’s stock price is about $80, while Amazon trades at $968 per share. By every financial matrix, Wal-Mart crushes Amazon from revenues and revenue growth, earnings and growth, and even net profit margins. Wal-Mart makes more profit each quarter than Amazon has made in total over 20 years of business. Even Amazon’s 2016 annual revenue is less than Wal-Mart’s 2016 quarterly numbers.
But if you had purchased Wal-Mart stock 10 years ago, not including cash dividends, you would be about break even. Amazon would have given you a 1,200 percent profit. Wal-Mart trades at a Price Earnings Ratio (PER) of 19; Amazon’s PER is 244.
Maybe investors are betting that someday Amazon will make as much money as Wal-Mart. That’s reasonable. But if by some miracle Amazon did equal Wal-Mart’s $14.7-billion annual profit next year, the stock would still have a PER nearly double of Wal-Mart’s just for the price to remain the same as today at about $970. Amazon and Wal-Mart are trading under two different rules of what a reasonable stock price valuation should be.
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E-mail me at mangun@gmail.com. Visit my web site at www.mangunonmarkets.com. Follow me on Twitter @mangunonmarkets. PSE stock-market information and technical analysis tools provided by the COL Financial Group Inc.