You need every edge you can get to succeed in investing, and sometimes it's the simplest tricks that get the most mileage.
So here's one incredibly smart trick that you definitely need to know: Don't look at the price of a stock before buying it. Price simply doesn't matter, whether it's a penny stock or something priced upward of $1,000 per share. Here's why.
Prices aren't how to find bargains
Imagine you're a buyer in a market for non-standardized bars of gold, which you expect to become more valuable over time due to the metal's scarcity. Sometimes a 1 oz bar of pure gold might sell for $1,200, and other days, the same 1 oz bar might cost you $1,400 or more. To complicate things, the bars for sale are often of varying weights.
Knowing the typical range of prices given the above variables, you probably wouldn't want to pay something ridiculous like $3,000 for a 1 oz bar if that's the price of the day; it's likely that such abnormally high prices are temporary. Nor would you want to pay $1,000 for a 0.5 oz bar, as the "low price" belies the fact that the bar is actually also quite expensive per ounce. But with stocks, investors do it all the time, because they look at the price of the shares (how much a bar costs today) rather than the amount of value they're getting for each share (the price you pay per ounce of pure gold in the bar). And that means they end up routinely overpaying.
Let's look at an example with AbbVie, (ABBV 1.11%) and Amazon (AMZN -0.40%). Amazon's shares are priced around $86, and AbbVie's are around $162. Using a few simple valuation metrics, we can come up with a few measurements about how much meat there is on each of their shares.
First, we'll examine the price-to-earnings (P/E) ratio, which tells you the cost you pay per dollar of a company's net income if you buy the stock. Amazon's is 79, whereas AbbVie's is 21.5, so Amazon's shares are more expensive for the right to control the same amount of earnings. There could well be compelling reasons to buy shares of Amazon rather than AbbVie, as the two companies compete in different industries and have dramatically different business models. But when it comes to the actual value that investors get with each share today, it isn't a close contest, and Amazon is the more expensive stock by far despite its lower price per share.
There's more than one reason this trick will make you better
Getting in the habit of scrutinizing a stock's value rather than its price is helpful for stretching your investment dollars as far as they can go.
But getting a bad deal at the time of purchase is only one issue. Companies don't grow at the same rate, and valuations factor in the expected growth of an enterprise in the future, so more- expensive shares in terms of their value today are often more attractive than cheap shares that won't grow as much. And a stock's price contains absolutely zero information about how much a company will grow.
Another common fallacy with price is that stocks with "low" prices are more likely to rise (or grow their revenue or earnings) than those with "high" prices. For instance, Wall Street analysts expected on average that the cannabis business Cresco Labs would expand its sales by 3.1% in its 2022 fiscal year. Its shares are currently about $1.89 each. But analysts also expected AbbVie's top line to rise by 3.9%, even though the stock's price is many times that of Cresco's.
So there's nothing inherently positive or negative about low prices per share. And shedding that illusion is yet another reason that ignoring the price altogether will make you a better investor. Keep your eyes on what matters in the long term: business factors driving changes in the value of a business, not share prices.
