Is a $5 Stock Cheaper than a $30 Stock?
Oct 8th, 2008 by Carlos
We all have certain pet peeves in life. I have several: when someone starts spouting off baseball stats without knowing what they mean, people who don’t know how to walk, and traffic. I’m sure you have your own too.
When it comes to investing and stocks, this is probably the thing that bothers me the most: when someone says that a stock is “cheaper” than another simply because the price is lower.
It’s just not true. Sure, it’s “easier” for a $5 to double to $10. After all, it just has to go up $5, right? While a $30 stock needs to go up a full $30 for your money to double.
The problem with this kind of thinking is that you’re looking solely at the stock, not the company behind the stock. It’s like relying solely on stock charts to make decisions—not wise. There are a wealth of numbers out there that can tell you so much more about a company. Paying this much attention to stock price is like picking the best baseball player of all time based on his jersey number—it makes no sense at all.
Unfortunately, it’s novice investors that often fall for this trap. I hear it all the time, “Wow, it’s only $6.34! That’s cheap!” They are scared off by stocks like Google ($346) and Berkshire Hathaway ($4,125)because they are so “expensive.” They might be, but the stock price is not the number that will tell us that. If you really want to simplify things, at least take a look at the P/E number. The P/E doesn’t tell the whole story, but it’s a good place to start when trying to get the value of a stock.
It tells you what the price is relative to the earnings that the company is actually making. Google, for example, has a P/E of 22. Yahoo, whose stock price is $14, has a P/E of 20. Pretty comparable no matter how different the stock price may seem.
For example, IBM trades at $95 and has a P/E of 11. Microsoft, on the other hand has a higher P/E of 12 (the higher the P/E, the more expensive the stock) and a price of $23. So it looks like Microsoft might be more expensive than IBM—despite the price difference.
When companies can arbitrarily change the stock price, you know you can’t read too much into it. If the Washington Post (trading at $486) wanted to make its price more “appealing,” it could do a stock split, which means every stockholder would get ten shares for every one they own, and the price would go down to a more “reasonable” $48.60 cents. How fishy is that?
It’s the reason why Warren Buffett refuses to do it to his stock, no matter how high the share price goes (an A share of Berkshire Hathaway costs $124,000). As he puts it:
“Berkshire’s shareholders think of themselves as partners in the company who are interested in its long-term prospects, not the movement of its share price.”
For all you investors out there—there is enough to worry about, especially now. Don’t fall for this trap. Instead, try to learn something concrete about the actual company behind the stock: what they do, how they do it, who manages it, what people think of their products, etc. Then take a look at the numbers that actually contribute to the story and go from there.
The lesson here is that you shouldn’t be after a low price, but a good value, and that has little to do with just paying attention to stock prices. Don’t let them fool you out there.
Full disclosure: I own a B share of Berkshire Hathaway
Amen! I really hate it when I hear people talk about stocks being cheap in terms of their price per share, when they have no idea about what the true intrinsic value of the company is. As you say, there are many factors to consider when determining the valuation of a company, and I also agree that P/E is definitely a good place to start. Another major factor to consider is profit margin. Companies with slim margins may fall hard under poor economic conditions, as they will be unable to reduce prices to draw business to increase their sales volume.
Excellent distinction here. This helped me come up with a simple illustration using my blog as an example: If I sold 10 shares of Mrs. Micah for $100 each (hmm…there’s an idea), it would be a little pricey. But if I sold 100 for $10 each, it’d be cheap. But either way, I’m either worth something or I’m not.
I think I may write about it at some point.
[...] Is a $5 Stock Cheaper than a $30 Stock? It depends. WC does a nice job here of pointing out that just because a stock’s price is cheaper doesn’t mean it is a great value. You have to dig into the numbers a bit more before making that determination. [...]
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Great explanation! I agree, and I’m also glad you pointed out that it’s smart to learn about the company you’re investing in. Particularly when you’re a beginning investor, I think it’s best to start with familiar companies that are already a part of your life.
Great post. This misunderstanding and the splitting of stocks has lured the “beginner trader” in many a black hole.
[...] Why does this make me so angry? Because they don’t understand the complexity behind what they’re saying. They think that “Buy low, sell high” is a solid piece of responsible, investment advice. A nugget they can repeat at cocktail parties to sound smart, sensible, and in-the-know (it’s right up there with thinking a stock is “cheap” because the price is “low”). [...]
ummm gawd… a 5 dollar stock is cheaper and can easier double faster than a 300 dollar stock. It’s not guaranteed. But it is easier, and cheaper. duh-value and performance of the company are the most important considerations, but a cheaper stock is cheaper!