Should You Avoid High Priced Stocks?

How many times do I hear an investor, especially beginners, rationalize why they did not consider buying a high priced stock. Their rationale: “they are expensive”. They judge the attractiveness of a stock as an investment by its stock price. This is understandable because the first thing they ask and learn before even asking in what business the company operates in is “What is the price?”

Because the objective is to make money, they assume that a low priced stock is more likely to appreciate more than a high priced stock. From what I can tell they probably reached that conclusion by assuming the following:

  1. They assume that a low priced stock suggests a smaller company and therefor e more likely to grow faster than a high priced stock which represents a large company. After all, most understand that it is easier for a Php10 million company to increase to a Php20 million company than it is for a Php100 million company to grow to a Php200 million company.
  2. They assume that a low priced stock is undervalued relative to a high priced stock. Over time, an undervalued investment is indeed more likely to appreciate faster than an overvalued investment.

These assumptions are obviously flawed for the following reasons:

  1. The size of a company is not a function of the stock price, but of market capitalization (the total value of the company’s outstanding shares). Meanwhile, total market capitalization is the product of the share price and the number of shares outstanding. A low priced stock could therefore be a much larger company if the number of shares outstanding is that much larger. For example, Ayala Land (ALI) is trading at around 25 while DMC Holdings (Consunji company) is trading at 56. It would be a mistake to think that the DMI Holdings, a construction company is twice as large as Ayala Land because of their stock price comparison. In fact, Ayala Land, with a market capitalization of about Php 350 billion is more than twice as large as DMC Holdings, whose market capitalization is Php 150 billion. The shares outstanding of Ayala Land is more than four times that of DMC Holdings.
  2. There are various ways of measuring how much a company is worth (its value). (Unfortunately it is not a simple enough subject that I can cover in a short blog as this.) Irrespective, because investors go through periods of extreme optimism and extreme pessimism, there are periods when stock price could be trading much higher than what it is worth (overvalued), or trading at much lower than what it is worth (undervalued). Being overvalued or undervalued however is just as likely to happen to a small company as it is for a large company.

So the next time you decide to avoid a high priced stock, think again. The company might not be as large as you think. And more importantly, do not think for a moment that its appreciation potential is limited.

And do not fret if all you can purchase of a high priced stock is one share! The highest priced stock in the world is probably Berkshire Hathaway Class A stock, currently selling at $176,000 a share. (that is a share, in dollars). It is the company that Warren Buffett manages, by far the most successful investor in history. He is also the second richest person in the world with a net worth of $60 billion (that is billion dollars). A $10,000 investment in his fund in 1966 would be worth $300 million now. In this case the highest priced stock is also the most successful.

How To Make Your Child A Millionaire

It is every parent’s hope that their child have a great future. Among other things, perhaps be a millionaire.

Assuming you are not rich enough to hand in a million dollars to your child in your will, how can you help your child be a millionaire? Certainly one way is to help your child get a good education. Help the child marry a rich partner maybe? Buy your child a lotto ticket every month and hope he/she wins the jack pot? You probably have other ideas yourself.

How about this? You can save $2000 ($167 per month) every year can you not? If you can and you invest every one of them in the stock market, by the time your child is 45 years old, he or she would be a millionaire, $1.2 million in his stock account to be exact. Assuming you had your child when you were 30 years old, you would probably even be alive at 75 years old to see your child enjoy his/her million.
In coming out with that estimate, I assumed a yearly return including dividends in the US stock market of 10%, the average return over almost 100 years.  Of course there will be some volatility in the US stock market returns from year to year ( such as this year the S&P 500 earned almost 30%), but I think in the next 50 years an average return of 10% including dividends is probably reasonable.

Who knows, you might even be lucky to find an investment manager that can beat the averages by 5% each year. They do exist, it is not farfetched. Beating the averages is every investment manager’s goal, and there are hundreds of them trying to do that. If you earn 15% return every year, your child will have a lot more, $5.4 million to be exact.

What about this? You probably know that Warren Buffett is by far the most successful investor in history. He is the second richest person in the world with a net worth of $60 billion (that is billion). A $10,000 investment in his fund in 1966 would be worth $300 million now for a yearly return of about 25% over 47 years!

If you find a person like that to take care of your portfolio and duplicate Warren Buffett’s performance, your child’s stock account would be worth a whopping $118 million! By then even you would be extremely wealthy, assuming your child gives you some of his money.
So what are you waiting for? Start saving and start investing in the stock market now and see your child become a millionaire. It is important to start early. If you wait until your child is 12 years old, instead of a stock portfolio worth $1.2 million at age 45 as I described earlier, your child will only have $490 thousand. Not bad. But not being a millionaire, your child will probably not be happy.