How Much Does Stock Price Even Matter?

Should investors care about the number they see first?

Mar 29, 2014 at 11:00AM

Source: Flickr / r-z.

All over the sides of investment websites are spam ads telling people how they can buy stocks for only pennies. For individuals with less investing experience, these ads can work by tricking these people into thinking they're getting an amazing bargain.

But more experienced investors know that penny stock spamming sites are usually set up in a way to ensure the real profits go to the stock promoters, not the person clicking on the ad. In fact, not only are the ads misleading, but the super low stock price can also serve as a red herring to trick people into thinking they're buying on the cheap when they really aren't.

But outside the penny stock world, how much does the actual share price really matter?

Adjusting the price
Through the use of forward and reverse stock splits, companies can adjust their share price into a range they see as more beneficial to the company. For example, share prices below $5.00 carry less corporate prestige and keep some institutional investors out (more on this later) but with a shareholder vote, a reverse split can carry shares back up to higher levels.

Citigroup (NYSE:C) and American International Group (NYSE:AIG) took advantage of reverse stock splits after their share prices tanked below $5.00 following the 2008 financial crisis. Citigroup's 1 for 10 reverse split and AIG's 1 for 20 reverse split carried the share prices back into the same nominal range as more stable institutions that weather the crisis.

Other companies have used forward stock splits to make shares closer in nominal price to peers and other major companies. Today, Microsoft (NASDAQ:MSFT) is worth around $335 billion but shares trade for around $40 each. Microsoft didn't start out with its current 8.3 billion shares; instead it underwent a total of seven 2 for 1 stock splits and two 3 for 2 stock splits since 1987. All this has helped to keep Microsoft's nominal share price relatively stable while the company has vastly grown in value.

Stock splits are common within the market and have allowed companies to control their nominal share price even after major growth or major collapse.

Institutional demand
As arbitrary as stock prices themselves may seem considering the ways companies can change them through forward and reverse stock splits, many institutions still require a share price of at least $5.00 to buy a stock. This was a major reason behind the reverse splits at Citigroup and AIG, as both companies wanted to keep their stock as something big institutional buyers could purchase.

Exchange rules
The New York Stock Exchange and the NASDAQ have many rules for maintaining a listing and among those rules is a minimum share price requirement. Both exchanges threaten to delist stocks that trade under $1 for an extended period of time, however, companies are allowed to run a reverse split to boost their share price higher.

Although both exchanges temporarily suspended the rule during the worst of the 2008 financial crisis, the rules are back in force today. When a company falls on tough times and its share price falls below the $1 level, the exchanges will serve them with a notice. In many cases, the company will run a reverse split thereby satisfying the requirements while not actually changing anything in terms of operations or finances.

Should it matter to you?
Since companies can generally adjust their share price to the nominal level they want, share price itself should not be a major determinant in investing. Instead you should look at the fundamentals behind the company and whether its particular characteristics of dividends, value, and growth make it a buy or sell.

You should also look at the share price performance charts as these factor in forward and reverse stock splits and provide a better picture of company history than current share price alone.

What should you look for in a stock?
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Alexander MacLennan has the following options: long January 2015 $40 calls on Citigroup, long January 2015 $45 calls on Citigroup, long January 2015 $50 calls on Citigroup, long American International Group warrants. This article is not an endorsement to buy or sell any security and does not constitute professional investment advice. Always do your own due diligence before buying or selling any security. The Motley Fool recommends American International Group. The Motley Fool owns shares of American International Group, Citigroup, and Microsoft and has the following options: long January 2016 $30 calls on American International Group. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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