There are two ways to value things that come in multiples. By multiples I mean things that contain a number of ounces, liters, gallons, shares of a stock, etc. The first and most common way is to look at absolute price. Perfect example from a recent trip to the grocery store. A 12 oz bottle of a cleanser costs $10.99. A brightly labeled “Value Size!” bottle has 16 oz and costs 14.99. Well, the value size is… obviously supposed to be a good value. You buy the $14.99 bottle.
You done gone and f*cked up.
The second way to value things is by unit cost. The math here is simple. Divide $10.99 by 12 (ounces). The result means 1 oz costs apx .92 cents. So if the other bottle of 16 oz should obviously cost less than .92 cents per oz. Right? Easy enough. Well, 16 x .92 cents = 14.72. Hold up… that’s .27 cents cheaper than the 14.99 price.
You’ve now 1. bought more of a product and 2. paid a higher price. Pretty sweet deal for the manufacturer and the retailer.
You may say “well, it’s only .27 cents, who gives a sh*t” and that’s fair. But if you start multiplying these price differences up in the hundreds and thousands of dollars it makes a bit more of difference. Especially if you keep making the same stupid mistake.
It’s tiring to hear over and over again that the share price of a stock is too high so it’s too expensive. One share of NVR (a phenomenal homebuilder stock) is $2,639.98. A share of AMD (a semi-conductor stock thats massively popular with gamers) is $24.17. New investors look at the 2 stocks and say that obviously AMD is a hell of a lot cheaper than NVR. Well, AMD is actually over 5x times more expensive…
In this example, we’re going to use the price/earnings (p/e ratio) that we discussed in our last lesson. Remember, Price to Earnings is simply the price you pay for a stock divided by the earnings your share makes in a year. In the last year (TTM or trailing twelve months) NVR has earned $195.31 per share. God d*mn…nice. AMD, the “cheap” stock, has earned .32 cents per share.
NVR’s Price/Earnings (p/e) is then $2639.98 (share price) divided by $195.31 (earnings)
which equals a p/e ratio of 13.26.
AMD’s p/e is $24.17 / .32 cents, which equals 74.61.
What would you rather pay 13.26 or 74.61? It’s not dollars, it’s a relative valuation, but it works the same way. Which leads to the conclusion that…
Just because the price is low, does NOT mean that something is cheap. Just because the price is high, does not mean it’s expensive.
If you want to get better at valuing things quickly, the grocery store already has a perfect way built in with many products. Most people never look at this, but it’s on nearly every label. Unit cost is written directly on the label. Think of unit cost as the p/e ratio in stocks.
From now on you need to start looking at that unit price label before making your decisions. In the above example, the bulk buy is truly a good deal. The unit price for the 62 oz bottle is less than half the true cost of the 8 oz bottle. In reality though, it can be about a 50/50 chance depending on the store. One thing to note is that if something is on sale you want to look at the adjusted unit price written on the sale label and not the white (typically) regular price label.
Start doing this on a regular basis and you will quickly and completely change how you think about the prices of things. It’s an easy one step closer to becoming a better investor.
NOTE: Arm & Hammer Baking Soda is made by Church and Dwight (CHD stock symbol). CHD has returned an annualized 18%+ since 1995… May be worth a look when it’s not too expensive. Hint Hint