Saturday, June 27, 2009

Does Price Matter?

Does the market price of a stock play a significant role in your decision to buy, or not buy shares in a company? For me the answer to this question has always been no, I look at rate of return and give almost no credence to stock price. If I invest $100K in a company it is of little interest to me if I get 5 stock or 500 stock in this company as long as I see a return on my initial investment. I have a good friend who will only buy a stock if it is trading for under $5. Are there advantages to his system?

Lower Price does not mean OTC & PK

A precursor; when we speak of lower stock prices in this article it is worthwhile to mention we are not talking about OTC or pinksheet stocks. The financial rules for these companies are loose and create a level of risk unto themselves. What we are talking about is index traded quality companies that just happen to be priced at a low value.

Lower Price = High Fluctuation

When a small or mid size investor goes to buy a stock they will often give little regard to buying a stock that is $0.15 more expensive today than it was a week previous. This is an advantage for this investment theory, a $0.15 shift in a stock price can equate out to a 3-10% increase in the stock's value if it was originally purchased at $1.50-$5. The same does not hold true of higher priced stocks. So, as a result of this mental block over small numbers an investor can get a sizable return with very little actually happening in the business to merit the change.

As easily as things fluctuate up though things can also fluctuate in the inverse direction, a drop of $0.15 can also easily occur for the same reasons.

Lower Price = Lower Volume

Often, but certainly not always, a lower price may be associated with a company that has limited trading volume, or may be dominantly owned by major institutions who don't trade the company frequently. This means that when it comes time to sell you may find you have trouble unloading your stock all at once, you may be forced to sell out gradually which can interfere with your liquidity plans.

Lower Price may = Small company

A lower price may mean that the company is a small cap business. Small caps are very different animals and as such there are a few pros and cons to dealing in these types of stock:
  • Management are often less experienced meaning they may not fully understand how to get you the return you desire.
  • Little may be understood of these companies by the larger investment world. Meaning if you have a solid understanding of the core business and are right with your predictions there may be substantial profit to be had.
  • A buyout is always possible, but so to is a bankruptcy.
  • There are less stock available meaning when people want it the price can easily get driven up, or alternatively driven down.

Weighing it out

There are some challenges and rewards in trading exclusively in cheaper stocks, the appeal of a larger fluctuation in price is very compelling. What do you think though?

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