(May 16, 2011 update: All future stock posts will appear on my new subscription-only website at www.GoodfellowLLC.com. Please visit!)
These questions cannot be answered in a vacuum, so let's look at contributing factors. First of all, stocks do not go up and down because of pricepoint. Stocks go up and down because investors either like the prospects of a company, then buy the stock, thus driving the price up; or they dislike the company's outlook, and sell the stock, thus driving the price down. In basic economic terms, these actions are referred to as "supply and demand".
While there are investors who buy modest numbers of shares in low-priced stocks, the larger number of shares traded each day are bought and sold by investment firms, mutual funds and other entities which would never make these decisions based on share price alone. They look at the "fundamentals", meaning sales, profit, debt, products, competitors and the like, or "technical indicators", meaning price charts, volume of shares traded, etc., neither of which has anything to do with whether the stock costs $12 or $56.
So the big thing we glean here is that if professional investment companies are not making their decisions based on the price of the stock, neither should you, the novice.
If we have two companies with the same exact sales and profit and products and future outlook, essentially, if all factors are equal, then the lower priced stock will be more of a bargain and have more profit potential for the investor. But the reality is that when you look at the earnings per share of a $12 stock, the number is often negative or below $1.00 per share, while the earnings per share of a $56 stock might be $3 or $4 or $5.
Earnings per share, a.k.a. "eps" is a number which helps you compare apples to apples. This number takes the company's annual net profit and divides it by the number of shares of stock which are outstanding. Generally speaking, a stock with an eps of $4.25 is going to command a much higher stock price than a stock with an eps of $0.63.
An even easier way to look at the stock price and the earnings per share and make a guess as to whether you're getting a good value for your money is to look at the price/earnings ratio, a.k.a. "PE". A $15 stock with an eps of $0.50 has a PE of 30. A $40 stock with an eps of $4.00 has a PE of 10. Generally speaking, a lower PE indicates lower risk to the share price. So you're really not comparing a $15 stock to a $40 stock in this scenario. What you're comparing is a stock with a high PE of 30 to a stock with a low PE of 10.
There is so much more to discuss and learn, but this is a brief lesson with a moral: "Professional investors do not make it a goal to buy low-priced stocks, and neither should you. Learn more about the balance sheet data which attracts professional investors, and try to buy stocks with similar attractive qualities. In doing so, you will lower your risk that the stock price will plummet, or simply fail to rise."
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FYI -- The lowest-priced stock I own right now is Fifth Third Bancorp (FITB) with a price of $15.39, projected 2011 eps of $1.15, and a PE of 13.4. The highest-priced stock I own right now is United Parcel Service (UPS) with a price of $74.34, projected 2011 eps of $4.25, and a PE of 17.5.
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The Right Huff is Crista Huff's blog for politics and items of sociological or financial interest. Crista Huff also manages Goodfellow LLC, a subscription-only stock market website. We strive to identify financially healthy companies in which traders and investors can buy shares and earn dividends and capital gains. See disclaimer for the risks associated with investing in the stock market. See your tax advisor for the tax consequences of investing. See your estate planning attorney to clarify beneficiary and inheritance issues associated with your assets.
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