There are many mistakes investors make when we look at stock prices. For starters, there's the mistake of thinking that a low price is a good thing -- and by low, I mean a few dollars. Or even $20, when compared with a $50 alternative. For example, as I type this, Citigroup shares are below $3 per share, and shares of American International Group are trading around $1.
If you're thinking those are bargain levels simply because you can count to the share price on the fingers of one hand, think again. Remember that you really need to have two prices in mind when you buy a stock -- its current price, and its intrinsic or fair value: what you think it's really worth. A stock may be trading at $1 per share, but it may well be worth just half of that. If so, it's more likely to head south over time than to surge.
Meanwhile, some stocks sport seemingly steep prices, but might be bargains. Insurance operation Markel
But here's perhaps the best example: Also rated five stars is Warren Buffett's company, Berkshire Hathaway
When looking at a share price, also be sure to look at the company's market capitalization, which is the share price multiplied by the number of shares. That tells you the total value that investors are placing on the company right now and is much more meaningful than its share price. (Without knowing how many shares a company has, the price of each is kind of meaningless.) Borders
Don't focus on quantity
Some people get excited about low-priced stocks because they can buy a lot of them with relatively few dollars. If you have $3,000, you can buy one class-B share of Berkshire Hathaway, or more than 1,000 shares of American International Group. Unsophisticated investors will assume that 1,000 shares is better than one, but they need to ask themselves which stock is likely to go up more, and how safe or risky each stock is, among other things.
This kind of thinking is what makes lots of people lose lots of money on penny stocks -- they get excited at the prospect of owning 20,000 shares of a $0.03 stock (for just $600), not realizing that it's more likely to go to $0.01 or less than to $3. Remember that if you buy one share of a $3,000 stock and 3,000 shares of a $1 stock and they both go up by 10%, the share price makes no difference: You'll still be up the same $300 on each position.
Another way to end up with 3,000 shares is to buy into a healthy, growing company that splits its shares. (Not all companies split their shares, though -- that's why Berkshire's shares are priced so high.) A two-for-one split will give you twice as many shares as you currently own, at half the price. The net change in their value? Nada. Splits aren't really such a big deal -- unless you like the idea of owning lots of (lower-priced) shares.
But here's another split-related caution: Sometimes a stock you're following can suddenly appear to surge in value, by doing a reverse split. A reverse split leaves you with fewer shares, but at a higher price. When a company's stock price falls to embarrassing levels, it may do a reverse split. It may also do one in order to meet listing requirements for the stock exchange where it trades. Borders, by the way, aims to do a reverse split, as does Rite Aid
What to do
So, never put too much stock in a company's share price without getting more context. Focus on the stock's value -- how undervalued you think it might be and how well it might serve you. (And don't put this off, as this is a great time to be a value-oriented investor.)
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Longtime Fool contributor Selena Maranjian owns shares of Berkshire Hathaway. The Fool owns shares of Berkshire Hathaway and Markel, which are Motley Fool Inside Value picks. Berkshire Hathaway is also a Motley Fool Stock Advisor selection. The Motley Fool is Fools writing for Fools.