Quote:
Originally Posted by Enoch Root
You can't use mkt cap to compare debt, as mkt cap is a function of price. The higher the price, the higher the mkt cap, the better the ratio. So let's raise the price!
Also, debt matters, absolutely. But it's a question of the cost of the debt, as a function of earnings (as long as the debt is at reasonable levels). And the cost of that debt is already factored into the earnings (i.e. earnings are net of debt service).
TSLA makes about $3.25/share and is priced at $150, or 47 X earnings
VW makes over 32 Euro/share and is priced at 123 Euro, or 3.7 X earnings.
Each dollar of earnings (per share) that TSLA generates is being valued at 12 X what each dollar of earnings that VW generates is being valued at.
Saying they have less debt does not justify that.
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Of course debt impacts a company's market cap. Debt holders get paid before shareholders do, so a company's debt levels will reduce its market cap at a given enterprise value. If you were buying a business for $10M and it had $20M in debt that you had to take on, you're ultimately paying $30M for it. So when you're looking at market cap exclusively (which includes only publicly traded common shares, and excludes preferred shares and debt obligations) you're not getting the full picture.
Enterprise Value captures the total value of a business (basically what it would cost to acquire it), so when you're comparing companies with very different debt levels, you have to account for that in some way. Which makes simple P/E comparisons between companies with significant debt and those with virtually zero debt not all that useful.
It's like when people were buying houses in Alberta for $1 in the '80s. They weren't getting houses for $1, because they were taking on the debt owing. So if you bought a $1 house and rented it out for $5K a year, you didn't have a 500,000% cap rate, because that would be ignoring the debt. Similarly, P/E for high-debt companies will tend to be much lower than low-debt companies because the market cap reflects a smaller portion of the company's enterprise value.