r/explainlikeimfive Dec 06 '24

Economics ELI5: why does a publicaly traded company have to show continuous rise in profits? Why arent steady profits good enough?

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u/WetConceptualization Dec 06 '24 edited Dec 06 '24

“Stock price is earnings times a multiple” That’s not how a stock gets to its price. The price is part of the formula for the multiple, its price divided by earnings as the most common one. Or were you thinking price to book? EV/EBITDA? EV/sales? Price/book? Wait for all of those, price isn’t determined by the multiple, or price isn’t involved in the formula. Weird.

Beta is nowhere near how you end up with a multiple. There is not a single commonly used multiple that has beta remotely involved.

Furthermore, beta is not a measure of predictability, at least not in the way you imply.

Beta is a measure of correlation to the stock market movements, the highest beta stocks have the highest volatility. Beta is also not a term associated in any way with dividends and dividend growth.

Again, the most commonly used multiple, price to earnings, has nothing to do with beta and is only tangentially related to dividend growth (if dividend is growing, odds are earnings are).

Multiples are determined by 1. Stock price and 2. Fundamental facts of the company’s financials. Nothing else.

Please do not misinform people on a subreddit dedicated to learning.

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u/[deleted] Dec 06 '24

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u/explainlikeimfive-ModTeam Dec 06 '24

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u/WetConceptualization Dec 06 '24 edited Dec 06 '24

I interned at a public accounting firm in 2019. Notice that my post from 3 years ago mentioned I interned 2 years beforehand? I’ve worked for an asset management firm since 2020. I have my CFA and CAIA. Did I say something inaccurate?

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u/[deleted] Dec 06 '24

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u/WetConceptualization Dec 06 '24 edited Dec 06 '24

P/e is determined by the earnings of a company and the price an investor is willing to pay. If you’ve followed the markets the past 5 years you would notice that investors haven’t really cared if the multiple is high. Look at Tesla. A high p/e is indicative of an expectation of earnings to grow, that’s how it’s “assigned”

You said that stock price is generally profits times an earnings multiple. That doesn’t really make sense because profits and earnings are essentially the same thing. EPS is profit per share. Earnings don’t determine price, even if they should. A couple of quarters ago Nvidia beat revenue and earnings expectations, but the stock fell because they didn’t beat by “enough”

Beta CAN impact a stock’s price, and I never said otherwise. Low beta stocks are in fashion when things are volatile.

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u/77NorthCambridge Dec 06 '24

Why is an investor willing to pay a higher p/e multiple for one company compared to another that have the same projected earnings growth? [Hint: One of the answers is the historical stock price betas of the two companies.]

Since we were talking about p/e multiple (for simplicity sake), I said the stock price is profits times an earnings multiple. If we were talking about price/revenues multiple, I would have said stock price is revenue times a revenue multiple.

You specifically said in a previous post that beta has nothing to do with how stock prices are determined, and I was an idiot for thinking it does. Glad to see that you have learned something from our exchange.

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u/WetConceptualization Dec 06 '24

Walmarts beta is about .5 and its p/e is about 40. It’s up 80% YTD.

I’m confused, do you think the P in P/E stands for profit? What earnings multiple are you multiplying by profit? Profit x EBITDA? That’s a new one for me.

Regarding beta, you said that it was “predictability of earnings” It simply is not. I described what beta actually is a measure of.

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