As of January 2022, Amazon’s stock (AMZN) has reached the $3,000 per share mark for over a year now and is currently trading at around $3,280. Compared to most other major companies, Amazon’s stock seems exceptionally high on a price-per-share basis.
Even from a valuation standpoint, the company can’t be considered cheap either: Amazon currently trades at a P/E ratio of around 64, which may seem significantly higher when compared with the earnings multiples of other companies like Apple, Microsoft, or Alphabet.
While Amazon’s stock may not be the most expensive stock trading at the market, it is still reasonable to ask why the price of the stock has gotten so high over the past decades.
Why Is Amazon’s Stock So Expensive?
The reason for Amazon’s high stock price is that the company’s share count is low relative to its total market capitalization. Amazon could reduce the price for each share by splitting its stock further which would increase the total amount of shares outstanding.
Amazon already went through three stock splits since its initial public offering in 1997. However, with the stock currently hovering at the $3,280 per share mark, it can still be considered high and more difficult to be traded amongst most retail investors.
When investors talk about “expensive” stocks, most of them would refer to the value instead of the pure price of companies. The value is essentially the relationship between the price of a stock and its underlying prospects and fundamentals.
There are two distinct features about a stock that need to be separated from each other:
- The current price of a stock which can vary from one company to another.
- The prospects of the underlying business which can either be low or high in relation to the price that you pay for the stock.
In this case, Amazon is both an expensive stock in terms of its stock price and its valuation standpoint.
In order to understand why Amazon’s stock is priced so high, we could compare the company with another well-known business that has a similar market capitalization: Microsoft (MSFT).
Both companies have similar market value but their stock prices heavily differ from each other. Microsoft’s stock trades at around $230 per share which is only a fraction of Amazon’s stock price.
The simple reason for this divergence is the fact that Amazon has fewer shares outstanding than Microsoft. The formula for calculating the stock price is dividing the market capitalization of a company by its number of shares outstanding.
This essentially means that when a company has a lower share count, its stock price is going to be higher in comparison to other businesses that might have similar market value.
Right now, Amazon has over 500 million shares outstanding. If we divide the market cap of the company by the count of shares, we would come up with Amazon’s current stock price. Microsoft on the other hand has roughly 7.5 billion shares outstanding: A much higher share count which thus results in a substantially lower stock price.
»Learn more about the number of shares within a comany
Why Is Amazon’s PE Ratio So High?
The other question that can be asked is why Amazon is trading at a price-to-earnings ratio of over 60, while other major companies are all trading at less than 40 times earnings.
The simple answer is because different companies are growing at different rates, and investors are willing to pay higher premiums for faster-growing businesses.
People who are familiar with the price-to-earnings ratio may already know that generally speaking, the lower the P/E ratio of a stock, the more undervalued the company might turn out to be.
While this statement isn’t necessarily wrong, what also has to be taken into account is the fact that there always has to be a reason for a certain earnings multiple, which isn’t implemented in the multiple itself.
That’s because a simple PE ratio doesn’t imply the different factors that play a crucial role in the value of a company. In other words, the price-to-earnings ratio has significant limits because it doesn’t reflect the risk, growth prospects, and efficiency of the underlying business.
As a result, it really doesn’t make sense to compare the PE of a business like Amazon with other different companies (in terms of risk, cash flows, and growth) such as Apple or Microsoft.
In the case of Amazon, its price-to-earnings ratio is essentially a reflection of how much more of a premium investors are willing to pay for the future prospects of the company, meaning that many investors are expecting Amazon to grow at a more rapid paste than most other businesses that trade at lower P/Es.
»Learn more about the price-to-earnings ratio
Consequently, a company with a higher P/E ratio isn’t necessarily more overvalued than a different business with a lower P/E ratio. If Amazon is going to grow rapidly in the future, one could definitely argue with the fact that the price may be reasonable.
Just like any other valuation metric, pricing ratios of companies should only be analyzed in comparison with similar and comparable businesses, which operate under the same industry circumstances.
Conclusion
Amazon’s high stock price is primarily due to the reason that the company has a fairly small amount of outstanding shares compared to other major businesses.
Of course, the stock price wouldn’t hit such high levels if the company had never gone through substantial growth over the past years.
Amazon is also trading at a higher stock price in relation to its current earnings as investors are expecting the company to continue growing immensely in the future and are thus willing to pay a higher premium for the stock.
