Quote:
Originally Posted by opendoor
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.
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Of course debt levels matter - what I said was, you can't use market cap to compare debt levels, as the higher the market cap (regardless of whether it's warranted) the lower the ratio. Raise your stock price and your debt ratio goes down! Raise it more and you'll look even better!
Debt matters, but it is relative and industry specific. It is also good, up to a point - for a stable company, debt is leverage, and is good for shareholders.
Arguing that TSLA's P/E should be 10X that of other car companies, because they don't have a lot of debt, is a weak argument. As long as the debt is manageable, debt is not a problem (and for auto companies, large debt levels are pretty standard and are not a problem)
What matters for the P/E and market cap is profitability, and growth or profitability. TSLA's P/E of 47 assumes a LOT of future growth, which I think is way too iptimistic, as the other companies are closing the tech gap on them