Why a Lofty Share Price Shouldn't Scare You Away From a Stock

In this segment from the Rule Breaker Investing podcast, Motley Fool co-founder David Gardner sifts through his listeners' questions and comments to pick subjects to dive into for your elucidation and entertainment. He helps listener Jason explain to an investing novice friend why focusing on share prices out of context can cause you to miss out on companies that can provide you with powerful returns.

A full transcript follows the video.

This video was recorded on March 28, 2018.

David Gardner: Rule Breaker Investing Mailbag Item No. 2: This one comes from my friend Jason Newman. I know him as TMFJayNew, or maybe CMFJayNew. Jay is a contributor to our Motley Fool forum team and a lot to our site. He's also a longtime Motley Fool member. A guy I first met, I think, at a book signing back in New York City somewhere in the late 1990s. So, Jay, thanks for writing in.

You said, "Hey, David. I hope this note finds you well and that 2018 has been kind to you and yours. Looking forward to seeing you at FoolFest in a few months, if not sooner. As for my question, it's more of a favor to ask if you don't mind.

"While you touched on this subject during the Market Cap Game Show episode with Matt, I'm hoping that you can elaborate a bit more on the misconception that many people make with respect to their judgments of risk, accessibility, price, and more. I'll call it investability," that's Jason's term, "based solely on the share price.

"You see, I have this friend," Jason writes, "named Todd, who's one of the smartest friends I have. His mental capacity is astonishing, with a memory that rivals anyone I've ever met. He has this one skill where he can repeat written or spoken words back to you backwards in the most fluent, awkwardly eloquent way you've ever heard. If you listen closely, it's even phonetically correct. I'm sure you've had a laugh or two hearing your name spoken backwards, Rendrag Divad, but when you hear Todd read an entire sentence or paragraph backwards, while you read along to check for accuracy, his speed and precision are incredible.

But, I digress. The bottom line is that he's smart." Jason goes on. "In the last month it's been especially exciting for me to learn that my close, smart friend has begun to take a more active interest in investing for his future and that of his family; only, he keeps getting hung up on the share price.

"Todd, you should invest in Markel," I'd say after discussing his risk appetite, only to have him come back to me and say, "That company you suggested I consider? Markel? The insurance company you described as Baby Berkshire? Well, it's over $1,000 per share. Or Amazon." Jason goes on. Google. Priceline/ Booking. "Forget it. He's ignoring some of the best businesses of our time on share price alone.

Long story short. Even after I explain that share price is not, alone, a direct indicator of a company's value -- or investability, if you will -- my smart friend, Todd, still anchors to that number. Can you please help me explain? Thanks, as always, and Fool on!"

Well, I cast about for how to answer this one. I definitely have spoken to it many times before over more than a couple of decades, now. I'm trying to help you out, Jason, and I'm going to start speaking to you, now, Todd. I'm trying to help you out, and what I realized is that I'd written an essay, a short essay about this a few years ago and I was already answering this question, so I hope you find my dramatic presentation of this effective for helping, I would say, up your mental game as high within investing as it is within the spoken word. Here we go.

Yup, I wrote this four years ago this coming month, April 2014. This was the Rule Breakers introduction that I wrote to that issue. Here we go.

"Novice investors often lock onto the price per share of the stocks they're buying. They love low-priced stocks. Reasoning one, you can buy more shares of lower-priced stocks, and two, if it just goes from $2 to $4, I can double my money. It sounds about 10 times easier on the face of it to double your money on a $2 stock than on a $20 stock. Let's not even talk about a $200 stock.

But as Rule Breakers, we can see through the conventional wisdom, right? Conventional wisdom equals almost always bad here at The Motley Fool. I hope you will resist the instinct to pay much attention, if any, to the price of a stock, or how many shares you own. Follow Buffett's advice. Pretend every stock is priced at $100 per share. In other words, get away from anchoring on the price per share and the number of shares you own. Get focused, instead, on owning quality companies and giving them patience over time to prove their quality.

We last did this study four years ago, so let's update the story," I went on in this essay. "Let's look at the stocks that at their time of Rule Breakers recommendation had the 10 highest costs per share, and the ones that had the 10 lowest. For instance, the single highest-price stock that we've ever recommended at Rule Breakers was Intuitive Surgical at $567.06 a share in January of 2013. By contrast, the lowest-priced shares we've ever tapped were Orthovita at $4.19 in November of 2009. Now, grouping the highest 10 and the lowest 10, here's how they've done.

"The average performance of the 10 highest" -- again, this was at the time that I wrote this essay -- "up 64.8%. That's 21.4% better than the S&P 500. By contrast, the average performance of the 10 lowest-priced stocks we'd ever recommended was up just 14.7%, unfortunately minus 23.4% worse than the S&P 500. You read it right. Our highest-priced shares are way ahead of the performance gains of our 10 lowest-priced stocks.

"Now, I might opine that higher-priced stocks are usually on offer from larger, safer, and stronger enterprises, but I'm going to resist the temptation to assert that because my primary message to you is this: Don't focus on price per share either way. Focus on the amount of money you're putting into each stock, so if you have $1,000 to invest it truly doesn't matter whether you're getting 20 shares of a $50 stock or 500 shares of a $2 stock. What does matter, again, are all the other things we look at here at Rule Breakers : the strength of the management team, the competitive position of the enterprise, marketing, and technological savvy, consumer love, etc.

"To conclude, the data says that if you're going to look at price per share at all, favor the higher prices. But, overall, just tend to ignore price and splits. Here's Foolish -- cultivate a love for great businesses."

And that was the end of that response. Todd, I hope that was persuasive. Jay, I hope I helped you out. I will remind you, Jay, that if Todd doesn't listen to this, or you find this was ineffective, this was Plan A. Plan B is to make a bet with your friend. That's what I do with my friends. Anytime you want to prove something, make a bet.

For example, as we've talked about before on this podcast, here are a few easy bets to win. One of them -- say you're holding a number behind your back, one or two. You ask your friend, when somebody is looking, to double-check you behind your back. You say a dollar if you tell me which number it is. Most of the time they're going to say two, because one is too obvious, so probably more than two-thirds of the time people say two, so always be holding one. There's a dollar right there.

Here's another way to make a dollar, especially in a bar. Maybe people have been drinking alcohol, and especially if it's guys. Run up to a guy and start playing rock-paper-scissors right away for $1. You're like, "One dollar. Let's go. One, two, three, shoot." If you do it fast and hard like that with a little bit of adrenaline, he will shoot rock. You're going to shoot paper. You will win that bet more than half the time.

And finally, the baseball bet. Right? It's baseball time of year. This is a great fact. Jason, I know you're a baseball fan. Todd, I hope you're a baseball fan. One of my favorite facts -- another good bar bet in baseball -- the team that wins the baseball game two-thirds of the time scores more runs in a single inning of that game than the other team scores for the entirety of the game. Again, two-thirds of the time. So, there's some easy ways to win some bets.

Another one, to close, is to bet your friend that a small portfolio of higher-priced shares will probably beat his small portfolio of penny-priced shares. Good luck, Todd and Jason.