Please ensure Javascript is enabled for purposes of website accessibility
Free Article Join Over 1 Million Premium Members And Get More In-Depth Stock Guidance and Research

Investing for Beginners: Don't Make the Mistake of Avoiding "Expensive" Stocks

By Brian Stoffel - Oct 12, 2013 at 8:00AM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Simply looking at a stock's price tells beginning investors very little. Here are some other things to consider.

If you've paid off your high-interest debt and set aside a substantial emergency fund, congratulations! You're now ready to invest. But before you put all of your retirement money into your favorite company's stock, remember that investing for beginners can be a steep learning curve.

Source: Wikimedia Commons 

One of the most common mistakes I see from beginning investors is the penchant to shy away from "expensive" stocks -- generally those over $100 per share -- in favor of stocks with prices under $10. The thought process is pretty simple: "I could buy one share of a $100 stock, or I could buy 20 shares of a $5 stock. I think owning 20 shares is better than one."

In reality, there's absolutely no reason to take this approach, and in the long run it will likely prevent some of the world's best companies from earning a place in your portfolio.

Let's do a little math
Let's say you have $500 to invest. You do your research and find two companies that you're considering investing in. Company A has a product that you like, and management that you believe in, but its stock runs at about $500. Company B is mediocre, and you're not a huge fan of its products, but its stock only costs $5 per share.

You decide to buy shares of Company B based on thinking that goes something like this:

 

Stock Price

Shares Bought

Company A

$500

1

Company B

$5

100


You inherently feel better owning 100 shares of something than one measly share. But the error in thinking is that when you consider such an approach, you should include a third column in your mind.

 

Stock Price

Shares Bought

Total Money Invested

Company A

$500

1

$500

Company B

$5

100

$500


No matter the choice, your investment is exactly the same. You are putting $500 of your own money into owning a piece of a company. Whether that means you have one share or 100 shares means very little.

Price-to-earnings ratio
Here's where investing for beginners gets real tricky. What if Company A was earning $25 of profit for every share on the market, while Company B was earning just $0.01 for every share?

Then, Company A would be trading for 25 times its earnings -- or with a P/E of 25 -- while Company B was trading for a much more expensive 500 times earnings.

 

Stock Price

Earnings per Share

Price-to-Earnings (P/E)

Company A

$500

$25

20

Company B

$5

$0.01

500


Looking at things this way, Company B's stock is actually 25 times more expensive than Company A's -- even though the price of the stock may have you believe otherwise.

An example from real life
Let's say you want to start investing in smartphones right now. You have $1,000 and have narrowed your choices to Apple ( AAPL -2.35% ), Nokia ( NOK -1.48% ), and Research In Motion's BlackBerry ( BB -4.74% ).

Here's what your options look like:

 

Stock Price

Shares Bought

Total Money Invested

Apple

$480

2

$960

Research In Motion

$8.00

125

$1,000

Nokia

$6.50

153

$995

Source: Google Finance

Again, it seems appealing to go for Nokia because you can buy 153 shares, but when you look at the total amount of money invested the differences between these three investments is negligible.

Furthermore, by looking at each company's P/E we get a much better picture of what we are paying for.

 

Stock Price

Earnings per Share

Price-to-Earnings (P/E)

Apple

$480

$40.11

12

Research In Motion

$14.50

($1.80)

N/A

Nokia

$4.82

($0.44)

N/A

Source: Yahoo! Finance

Even though Apple's stock is more than 30 times as expensive as Research In Motion, and 100 times as expensive as Nokia, it's still much cheaper when viewed from the standpoint of earnings. Nokia and Research In Motion -- which have lost substantial market share to Samsung and Apple -- haven't even turned a profit in the last 12 months!

On top of that, both of these laggards have already agreed to be bought out, so buying shares now would yield very little gain. Apple, on the other hand, just released a cheaper iPhone that many people thought would be a bust, but ended up selling like hotcakes

Take the most important step of your financial future

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Apple Inc. Stock Quote
Apple Inc.
AAPL
$159.91 (-2.35%) $-3.85
Nokia Corporation Stock Quote
Nokia Corporation
NOK
$5.66 (-1.48%) $0.09
BlackBerry Stock Quote
BlackBerry
BB
$8.84 (-4.74%) $0.44

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning service.

Stock Advisor Returns
640%
 
S&P 500 Returns
139%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 12/03/2021.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Our Most Popular Articles

Premium Investing Services

Invest better with the Motley Fool. Get stock recommendations, portfolio guidance, and more from the Motley Fool's premium services.