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Chart adventures of the day

30 Aug 2012

Felix presents an interesting chart:

This chart plots daily observations of the market cap of Apple and Microsoft against the companies’ price/earnings ratio. The message is that Apple’s large market cap has coincided with the low price/earnings ratio of a mature company, while Microsoft at its peak was priced as a growth company.

Do you see the many clusters of dots that appear as line segments? They’re there because the “earnings” in price/earnings are only updated once a quarter.

Think of price/earnings-per-share as equal to market cap/earnings. For the 60-plus trading days in a quarter, when you plot market cap against market cap/earnings, all the dots are on a line with slope 1/earnings. You can justify plotting all the individual daily observations on the grounds that they represent independent valuations of Apple or Microsoft. The problem is that the chart interprets all increases in price/earnings during a quarter as an increase in a valuation ratio, but it could just as well be due to changed expectations of short-term earnings. The final chart looks messy and implies that there’s more information than there really is.

I’ve created my own version here that’s less visually exciting, but shows the same information in a more concise form. For each quarter, I’ve plotted the average of the daily market caps that quarter against the price/earnings ratio based on earnings during the previous four quarters. (This data is only through 2011 because we graduate students can’t afford the most recent data.) This chart illustrates the same underlying message without the line segment artifacts created by using daily observations.

(If the chart looks small, make your browser window wider or click through.)