We Homo sapiens aren't always rational about money, as my colleague Robert Brokamp explained in "Are You A Homo Moronicus?" I run across examples of this all the time -- both in print and in my own life.
Here's an example I recently read about in Money magazine: Researchers at Stanford and Caltech gave samples of the same wine to two groups of people. One group was told it came from a $10 bottle, while the other group was told it came from a $90 bottle. Want to guess what happened? "Subjects liked the 'pricier' glass almost twice as much."
What's going on? Well, the subjects were giving the price more meaning than they should have. We probably all agree that for each person's set of taste buds, there must be some delicious inexpensive wines and some awful expensive ones. Yet when we hear of a $90 wine, we tend to assume it must be better than less expensive ones, and vice versa.
Now to stocks ...
A similar thing goes on with unsophisticated investors and stocks, though it's kind of in reverse. If they're presented with a $10 stock and a $90 stock, they'll tend to think that the $10 one is more of a bargain, while the $90 one is more likely to be overvalued. This is very wrong-headed thinking, and I hope you don't engage in such folly.
Remember that you need to look at lots of factors when studying a stock, and that a stock's price is close to meaningless, unless it's related to some other numbers, such as earnings (via a price-to-earnings (P/E) ratio, for example), or share count (via market capitalization).
Think of Berkshire Hathaway (NYSE: BRK-A) (NYSE: BRK-B). A year ago, its class A shares were trading for around $109,000 each. (Don't give up hope, though, if you dream of owning a piece of Warren Buffett's company. Its class B shares are priced at one-thirtieth of the previous number.) While the six-figure price might sound ridiculously overpriced to the unsavvy, consider that the stock topped $150,000 in December, and was recently trading near $130,000. Similarly, Apple (Nasdaq: AAPL), Google (Nasdaq: GOOG), and CME Group (NYSE: CME) are just a few of the many stocks that trade well above $100 per share.
The key to remember, however, is that a stock's share price doesn't necessarily have anything to do with whether it's a good value or not. A company trading at $300 per share could be a bargain, while one trading at $3 could be ridiculously overpriced.
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