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:
- 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.
- 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:
- 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.
- 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.