Microsoft and Apple have PE ratios of 40 and 35, respectively.
Is Microsoft more expensive than Apple?
How about Nvidia with a PE ratio of 73?
Is Nvidia super overvalued?
And considering stock performance—with Nvidia gaining 180% compared to Apple’s 25% and Microsoft’s 26%—does that make Nvidia overvalued simply because its stock increased more?
The answer to all these questions is “not necessarily.”
The first mistake investors may make is to look at the PE ratio in absolute terms. This is particularly true for value investors who are used to single-digit PE ratios or at most, ratios in the teens. Seeing a PE of 73 might naturally trigger an alarm of overvaluation.
However, one must consider growth rates, not just the PE ratio in isolation. A stock with a higher growth rate will command a higher valuation, which is reasonable. For example, Nvidia’s earnings per share (EPS) grew by 803.1% over the last 12 months compared to the preceding 12 months. This would give a PEG ratio of just 0.09 (a PEG below 1 is considered undervalued). In other words, a PE of 73 can be considered cheap for Nvidia’s high growth rate.
Since the market is forward-looking, we need to project future growth rather than focusing solely on past performance. While Nvidia’s EPS growth rate will eventually slow, the exact figure is uncertain. However, we can use the PE ratio as a reference in relation to its growth rate. For instance, even if Nvidia’s EPS growth slows to 73%, a PE ratio of 73 is still justifiable because the PEG ratio would be 1. Thus, the market has already accounted for Nvidia’s slowing growth rate, and it isn’t as crazy as one might think.
The second mistake is comparing PE ratios across different stocks. For instance, comparing Nvidia’s PE of 73 to Apple’s PE of 35 does not alone indicate that Nvidia is a more expensive stock. The businesses are fundamentally different—Nvidia designs graphics cards, currently in high demand due to AI applications, while Apple is a consumer electronics company. Even if we classify them both as Big Tech or part of the Magnificent 7, their PE multiples are not directly comparable.
Comparing a stock’s historical PE ratio is more applicable because it reflects how much investors are willing to pay for the stock over time, cycling through periods of optimism and pessimism. While this method isn’t perfect since businesses can change (adding or removing products), it is a better yardstick than comparing dissimilar peers.
Below is the PE ratio for Apple, showing that it is trading above one standard deviation above its average, a sign of overvaluation.
Next is Microsoft’s chart, which also shows its PE ratio trading one standard deviation above its average, suggesting overvaluation as well.
Finally, Nvidia’s PE chart shows it trading slightly below its average PE. There was a spike in PE in 2023 to as high as 237.24, but the PE fell back to the average as Nvidia met high expectations by increasing its EPS by multiple folds.
Hence, in this perspective, the overvalued stocks are Apple and Microsoft, while surprisingly, Nvidia appears cheaper.
