Friday, July 8, 2011

When It Comes to Stocks, 'Cheaper' Is Not 'Lower-priced'

"Apple is too expensive for me."
This came from a fellow small-money investor a couple weeks back.
"Expensive how?" I asked.
The stock was selling for $325 a share, he said. To him, that was simply too much to pay for a share of any stock.
If he's going to spend $325 on stock, he wants more for his money. Like 30 shares. Or even 50. Even 150.
It wasn't too long ago that I thought like this, too.
Separating price from value is a difficult mental hurdle for beginning investors, and one that's not easily cleared.
Something instinctual seems to tell us that an item selling at a lower price is bound to be a better bargain.
But when it comes to stocks, this is far from true. And thinking this way will cost you opportunities.
I learned this on a very forgiving curve. I plunged into investing by Dumpster-diving for stocks after the 2008 crash. Everything was cheap. General Electric, the industrial behemoth now selling at $20, had plunged to under $6 a share.
To me, it made sense to grab onto some stocks that had fallen the farthest, because they seemed likely to rise the most.
The method was far from sophisticated, but at the time, it didn't need to be. Everything I bought was a winner. And in many cases, the lower the price, the bigger the gain.
Safe to say, I got lucky.
You can't try to evaluate stocks like that in any other situation and expect to be successful.
That's why it was important for me, like all newer investors, to learn to distinguish between a high-priced share and an "expensive" stock.

More room for growth?
Here's something to keep in mind when looking at stock prices.
A stock always has the ability to rise infinitely. Every stock also has the ability to fall to zero.
There is no inherently greater risk in buying a stock that's now $500 a share than there is in buying one that's $50.
Nor is there any inherently greater upside to buying a lower-priced stock. An expensive stock can just keep on appreciating if the company keeps growing. Take a look at the little burrito business, Chipotle, which now commands a $325-per-share price tag.

Price vs. value
One of the big determining factors in how much a share sells for is the volume of shares that are available. The more there are for sale, the cheaper the share.
Think about it like buying beer: Some stocks are priced by the keg. Others are priced by the pony bottle.
What we're looking for as investors is the best value.
Let's compare two popular stocks at polar ends, Apple and Sirius Satellite Radio.
Apple was selling for $325 that day, as I mentioned above. Sirius, for $2.09.
For every share of stock Apple has available, the company earns nearly $21.
For every share Sirius has for sale, it earns 4 cents.
But wait a second ... those Sirius shares are so cheap, all those pennies add up, right?
Just like those pony bottles can add up to a keg.
Not quite.
If you were to buy enough Sirius shares to equal the cost of one share of Apple, those shares would be resting on just $6.25 in earnings. That's less than a third of what Apple's making.
So, it's more like a pony keg to Apple's full barrel. For the same price.
The better bargain, and hence the truly cheaper stock, is Apple.

Go ahead, take a chance
Is this an argument against buying low-priced stocks? Not at all.
In fact, I often have a sub-$10 stock in my portfolio, and I've read research showing that they outperform higher-priced stocks in bull markets as a group.
But this is a reminder to not let yourself get tricked into thinking that low price tag makes a stock a better bargain.
Usually, there's good reason why those cheap stocks are selling so cheap.

Do you consider price in your stock purchases? Do you find lower-price shares a lure?

My portfolio up .57% on the year. See it here.


  1. I just started investing on my own and I think this blog is a great idea for newbies. Keep up the good work.

  2. Thanks for the compliments. It's great to read stuff written by experts to help us figure out where to invest. But I think sometimes, it's nice to read about people who are thinking through the same dilemmas we are.