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What Does a Low Stock Price Mean?
When many people begin investing in stocks, they don't have a lot of money to invest. Therefore, they tend to gravitate toward low priced stocks. After all, doesn't it sound more appealing to be able to to buy 10 shares of a $10 stock than 1 share of a $100 stock? But this type of thinking can lead to bad investment decisions.
To illustrate why, let's first imagine that instead of buying stocks that you are choosing between two different used cars. One of the cars costs $1,000 and the other costs $10,000. If both cars were the same make, model, year, condition, and had the same amount of miles, it would be an easy decision. You would buy the car that costs $1,000.
However, let's say that the car that costs $1,000 is 20 years old with 250,000 miles on it, needs a new transmission, and has rust all over it. On the other hand, the $10,000 car is only 3 years old, in great condition, and has only 20,000 miles. If you can afford both cars, isn't it an easy decision regarding which car to buy? You would buy the newer car that works and isn't covered in rust, right?
The same pricing principle holds true for stocks. Usually, there is a reason why a $10 stock costs $10 and not $100. The stock market is typically fairly efficient and usually prices stocks close to their true value. But how can you be sure a stock is priced correctly?
First, let's briefly outline the process of how stock is issued. When a company first makes the decision to become a publicly traded corporation, it then takes steps to issue stock. This initial stock sale is commonly referred to as the IPO, or initial public offering. The company decides how many shares they would like to issue and work with investment bankers to sell these initial shares.
Once the initial shares are sold, they are then available to the general public to be traded. The stock might be initially sold somewhere between $10 to $20 per share. As time goes by, the price of the stock will go up or down for a number of reasons.
The basic driver of stock price is company performance. If the company does well and increases its profits year after year, the stock's price will generally go up over time. On the other hand, if the company doesn't fare well and its profits remain stagnant or decrease, the price of the stock will likely go down as well.
For precisely this reason, stocks with a lower share price are typically riskier than stocks with higher-priced shares. Since the likely reason the company's stock price is so low is that it hasn't performed particularly well, when you buy a low priced stock, you are betting that it is going to somehow change its course and start to perform well.
On the other hand, quality blue chip stocks are generally more expensive per share than their lower-priced counterparts. For example, Berkshire Hathaway's A shares are currently trading above $100,000 per share. While this is an extreme example and most investors probably can't afford to buy even a single share of Berkshire's stock, it helps to illustrate the point. Berkshire Hathaway is actually run by billionaire investor Warren Buffett who has managed the company extremely well over time. As profits have increased over time, the share price of Berkshire Hathaway's stock has followed suit.
On the other hand, it is not typically advisable to only look for stocks with a high share price. The reason is that if a stock splits, its price per share will almost always decrease following the split. For example, as a result of its recent acquisition of Burlington Northern Santa Fe railroad, Berkshire Hathaway announced that its B shares would be split 50 to 1. This means that each 1 share of stock that was previously priced at over $3,000 per share will be split into 50 pieces, and will consequently be worth around $60 per share. In this case, due to the stock split, the lower share price will not reflect the company's past performance.
Therefore, before you buy a stock, make sure to not only look at the current share price, but also research its history of stock splits. This will give you a better idea of the company's performance over time.
In conclusion, investors should not hastily buy stocks that have a low share price. Doing some research and understanding the past performance of a company as reflected in its share price can help to provide some insight into how well a company has been run over time and if it is likely to be a good investment.
Want to improve your investing strategy? Get started today with our FREE stock research tools OR read more investing articles.
When many people begin investing in stocks, they don't have a lot of money to invest. Therefore, they tend to gravitate toward low priced stocks. After all, doesn't it sound more appealing to be able to to buy 10 shares of a $10 stock than 1 share of a $100 stock? But this type of thinking can lead to bad investment decisions.
To illustrate why, let's first imagine that instead of buying stocks that you are choosing between two different used cars. One of the cars costs $1,000 and the other costs $10,000. If both cars were the same make, model, year, condition, and had the same amount of miles, it would be an easy decision. You would buy the car that costs $1,000.
However, let's say that the car that costs $1,000 is 20 years old with 250,000 miles on it, needs a new transmission, and has rust all over it. On the other hand, the $10,000 car is only 3 years old, in great condition, and has only 20,000 miles. If you can afford both cars, isn't it an easy decision regarding which car to buy? You would buy the newer car that works and isn't covered in rust, right?
The same pricing principle holds true for stocks. Usually, there is a reason why a $10 stock costs $10 and not $100. The stock market is typically fairly efficient and usually prices stocks close to their true value. But how can you be sure a stock is priced correctly?
First, let's briefly outline the process of how stock is issued. When a company first makes the decision to become a publicly traded corporation, it then takes steps to issue stock. This initial stock sale is commonly referred to as the IPO, or initial public offering. The company decides how many shares they would like to issue and work with investment bankers to sell these initial shares.
Once the initial shares are sold, they are then available to the general public to be traded. The stock might be initially sold somewhere between $10 to $20 per share. As time goes by, the price of the stock will go up or down for a number of reasons.
The basic driver of stock price is company performance. If the company does well and increases its profits year after year, the stock's price will generally go up over time. On the other hand, if the company doesn't fare well and its profits remain stagnant or decrease, the price of the stock will likely go down as well.
For precisely this reason, stocks with a lower share price are typically riskier than stocks with higher-priced shares. Since the likely reason the company's stock price is so low is that it hasn't performed particularly well, when you buy a low priced stock, you are betting that it is going to somehow change its course and start to perform well.
On the other hand, quality blue chip stocks are generally more expensive per share than their lower-priced counterparts. For example, Berkshire Hathaway's A shares are currently trading above $100,000 per share. While this is an extreme example and most investors probably can't afford to buy even a single share of Berkshire's stock, it helps to illustrate the point. Berkshire Hathaway is actually run by billionaire investor Warren Buffett who has managed the company extremely well over time. As profits have increased over time, the share price of Berkshire Hathaway's stock has followed suit.
On the other hand, it is not typically advisable to only look for stocks with a high share price. The reason is that if a stock splits, its price per share will almost always decrease following the split. For example, as a result of its recent acquisition of Burlington Northern Santa Fe railroad, Berkshire Hathaway announced that its B shares would be split 50 to 1. This means that each 1 share of stock that was previously priced at over $3,000 per share will be split into 50 pieces, and will consequently be worth around $60 per share. In this case, due to the stock split, the lower share price will not reflect the company's past performance.
Therefore, before you buy a stock, make sure to not only look at the current share price, but also research its history of stock splits. This will give you a better idea of the company's performance over time.
In conclusion, investors should not hastily buy stocks that have a low share price. Doing some research and understanding the past performance of a company as reflected in its share price can help to provide some insight into how well a company has been run over time and if it is likely to be a good investment.
Want to improve your investing strategy? Get started today with our FREE stock research tools OR read more investing articles.