I have a friend that works in a supervisory and budget role at a major corporation. Among other things, he pitches improvements (capital expenditure items) to management and must justify the cost and benefits. He's financially savvy, but he's totally new to shares, and he asked me on the weekend:
What is the share price?
After some false starts I managed to cobble together a passable explanation, but I finally settled on an analogy:
"Imagine that I worked for you and I came up and said 'I have a good idea, we can do a thing at the factory, it'll cost $10 million.' Do you do it?"
'Ah.'
He instantly understood. You see, the price of anything (of shares or otherwise) is never the full story. There are many things that can affect the price of shares. What's more, the share price doesn't tell you anything about a company's prospects.
The real question is always what do you get for that price?
Take iron miner Fortescue Metals Group Limited (ASX: FMG) for example. For $4.76 per share, the company earned US$0.316 (A$0.42) per share in 2016. It has modest debt and a modest price – about 11x its earnings – but is super sensitive to the iron ore price. If the value of iron ore falls, profits go down and vice versa. The total value of the company's shares (share price x # of shares on issue) is $14.8 billion.
Or, look at XERO FPO NZX (ASX: XRO), the accounting software company from NZ. For $23.98 per share, the company reported losses of NZ$0.50 per share (A$0.48) in 2017. On an earnings basis, the company looks outrageously expensive alongside Fortescue. However, it is growing its market share and revenues very rapidly and has very high profit margins. It is a different style of business and the market values it in a different way. The total value of the company's shares is $3.3 billion.
Blood products and vaccines company CSL Limited (ASX: CSL) is another business again. For $139.62 per share, the company earned US$2.683 (A$3.53) per share in 2016. It also looks quite expensive alongside Fortescue, but unlike Xero it is profitable and its products are life-saving. It is a market leader in its field, and has a research pipeline of new products that could potentially grow profits in years ahead. The total value of the company's shares is $63.36 billion.
That's not to say that you should buy or avoid any of the above companies. It simply reflects what diverse sorts of businesses you can buy, regardless of what the share price or earnings are. The share price is always the least useful piece of information you can know about a company.
