As I type this, Sprint Nextel (NYSE: S) shares trade below $5 per share, while shares of Level 3 Communications (Nasdaq: LVLT) trade for less than $2. But if you think those prices represent bargains, think again.
You need to keep two prices in mind when you buy a stock: its current sale price, and its intrinsic or fair value -- what you think it's really worth. A stock trading at $1 per share may well be worth just half that measly sum. If so, it's more likely to head south over time than to surge.
Lofty bargains
Meanwhile, stocks that sport seemingly steep prices might actually be bargains. Insurance operation Markel (NYSE: MKL), for example, recently traded around $360 per share. But it's also earned a five-star rating from our Motley Fool CAPS investor community, suggesting that many expect good things from it. Similarly, CME Group (NYSE: CME), trading around $310, was rated four stars.
Here's perhaps the best example: Class-A shares of Warren Buffett's five-star company, Berkshire Hathaway (NYSE: BRK-A) (NYSE: BRK-B), closed yesterday at more than $120,000 per share. Yet many consider Berkshire A shares significantly undervalued, even at that astronomical price.
When looking at a share price, also be sure to look at the company's market capitalization -- the share price multiplied by the number of shares. That tells you the total value that investors are placing on the company right now, a much more meaningful measure than its share price. (Without knowing how many shares a company has, the price of each is kind of meaningless.) Often, you'll find that companies with higher share prices actually have lower market caps, because they have fewer shares outstanding.
Don't focus on quantity
In addition, some people get excited about low-priced stocks because they can buy a lot of them with relatively few dollars. If you have $50,000, you can't afford a single class-A share of Berkshire Hathaway, but you can get more than 10,000 shares of Sprint Nextel. Unsophisticated investors will assume that 10,000 shares is better than one. But they need to ask themselves which stock will likely rise more, and how safe or risky each stock is.
This kind of thinking makes lots of people lose lots of money on penny stocks. They get excited at the prospect of owning 10,000 shares of a $0.05 stock (for just $500), not realizing that it's more likely to fall to $0.01 than to rise to $3. Remember that if you buy 10 shares of a $500 stock and 1,000 shares of a $5 stock, and they both go up by 10%, the share price makes no difference: You'll still be up the same $500 on each position.
Splitting shares
Another way to end up with 1,000 shares is to buy into a healthy, growing company that splits its shares. 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.
That said, 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 at a higher price apiece. When a company's stock price falls to embarrassing levels, it may do a reverse split. It may also do so in order to meet listing requirements for the stock exchange where it trades. AIG (NYSE: AIG) did a 1-for-20 reverse split last year, with amazing short-term results.
What to do
Never put too much stock in a company's share price without getting more context first. Focus instead on the stock's value -- how undervalued you think it might be, and how well it might serve you.
