Human Inequality Is Despicable, but Stock Discrimination on Wall Street Is a Good Thing
Today here in the U.S. we celebrated Martin Luther King Jr. Day, and most Americans had the day off to commemorate Dr. King's impact on American history and human civil rights. Dr. King dreamed of a world in which all people were treated equally regardless of race, creed, color, or religion, and his life was tragically cut short before that dream could be fulfilled. We still struggle today with these same issues, and we should continue to strive for a world where human discrimination doesn't exist.
Most of us have a negative association with the word "discrimination," and when it comes to the treatment of human beings, that association is appropriate. But when it comes to our investments, a slightly different perspective may be in order.
On the stock market, we can find a number of instances in which stocks are discriminated against, both justly and unjustly. Sometimes a stock has been beaten down based on industry trends, or a because a competitor reported comparatively good or bad earnings figures. Irrational moves like this amount to discrimination against a stock that may never have done anything wrong, but smart investors can take advantage and pick up an unjustly mispriced stock at a bargain.
Likewise, inequality can take on a different meaning in terms of investing. Look at Amazon.com or Tesla Motors to see what I mean. Amazon never records a large profit, and that's because Jeff Bezos has made it clear from the start that most profits will be rolled back into the business. But because Amazon isn't treated like other companies in the retail world, the stock price, on a price-to-earnings basis, looks insane. It currently trades at a mind-boggling P/E ratio of 1,447,
Similarly with Tesla, if we base what the company's market capitalization should be on the number of vehicles it sells, then the stock is insanely overpriced. In 2013, Tesla sold just over 22,000 vehicles, yet the company is currently valued at over $20 billion. For comparison, Ford is believed to have sold more than 2.5 million vehicles in 2013 -- more than 100 times as much as Tesla -- yet its market cap is only a little more than three times as large, at $65 billion. This is a type of discrimination against Ford, in that investors believe Tesla will grow at a faster rate than the older car company. So you can make an argument that the stocks are being treated unequally, yet they're also being evaluated on their own merit, which is a good thing.
But there's one place where discrimination in investing is just as negative as in other parts of life, and that's on the Dow Jones Industrial Average . Because it's a price-weighted index, it doesn't give an accurate picture of what the markets really look like. Its highest-priced stock, Visa, currently trades at $232.18 and makes up 9.06% of the Dow, while its lowest-priced stock, Cisco Systems, trades at $22.74 and accounts for only 0.89% of the index's weight. Yet the two companies' market caps aren't that far apart -- $147 billion for Visa, and $121 billion for Cisco.
The Dow's methodology thus fails to evaluate stocks based on their own merit (i.e., market cap) and instead judges them by their superficial outward appearance (the share price, which is the first thing investors usually see but doesn't always tell you much about the company).
So while inequality and discrimination can sometimes be a good thing for investors, that's certainly not always the case -- and it's something we should never tolerate on a human basis. So let's take some time today to thank Dr. King and everyone else who's fought and sacrificed so much toward achieving that goal.
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The article Human Inequality Is Despicable, but Stock Discrimination on Wall Street Is a Good Thing originally appeared on Fool.com.Fool contributor Matt Thalman owns shares of Amazon.com, Ford, and Tesla Motors. The Motley Fool recommends and owns shares of Amazon.com, Ford, and Tesla Motors. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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