The price is not the same as the value. While many know the difference between the two, I can't tell you how often I hear investors mix the two. It happened again recently when a family friend told me about how expensive the CSL Limited (ASX: CSL) stock price became after it exceeded $ 200 per share! I will not necessarily argue with this, except when he compared it to better evaluate stocks like BHP Group Ltd (ASX: BHP), which was trading around $ 38. No matter the fact that comparing stock valuations across sectors is not easy, but compare the …
The price is not the same as the value. While many know the difference between the two, I can't tell you how often I hear investors mix the two.
It happened again recently when a family friend told me about how expensive the family is CSL Limited (ASX: CSL) The share price had become after it exceeded $ 200 per share!
I will not necessarily argue with that except when he compared it to better evaluate titles like BHP Group Ltd (ASX: BHP), which traded around $ 38.
No matter the fact that comparing stock valuations between sectors is not simple, but comparing stock prices with one another is an error that must be avoided.
Are stock prices important?
More people than you think fall into this trap, even experienced investors. I remember having the same conversation with my mother a few years ago and invested in stocks since she became a teacher when she was 18.
The "logic" is that you can only buy 10 shares of a stock for $ 200 if you have a modest capital of $ 2,000, but you can buy 1000 shares of a company that trades at $ 2 per pop.
The limited number of shares you can buy in the first instance is not worth it and you have to get a better deal the lower the share price is.
The price is not equal to the value
There are several problems with this topic. As the legendary investor Warren Buffett said: price is what you pay, value is what you get. The two are not connected.
The small number of shares held in a $ 200 company may represent a significantly better value than the larger holdings in a $ 2 company.
This is because it is necessary to observe other measurements when comparing stocks. These include:
- Shares in circulation: A company of $ 200 is not necessarily larger than $ 2. It depends on how many shares have been issued. Market capitalization (the listed value of a company) is a function of multiplying the price of shares by the number of shares issued. The number of shares also has an impact on earnings per share, which is a key measure of value. In simple terms, a profit of $ 1,000 divided into 10 ways yields a better return for you than when it is divided into 100 ways.
- Growth rate and margins: Several companies in the same industry could increase sales and profits at different rates. Their profit margins could also vary materially. Investors usually choose to invest in the fastest growing company with the best margins as they tend to be managed better and have a brighter outlook, but it cannot be said which company is superior simply by looking at the stock price.
- Rate of return: This is an extension of the growth rate. The best-managed companies usually generate higher returns for shareholders and this can be seen through their return in terms of capital, return on assets or return on stock indices. You should only compare the rate of return of companies operating in the same sector.
- Balance sheet: All things being equal, a company with more money and less debt has more value than one with a significant amount of leverage. The share price alone will not tell you the amount of leverage in a company. You will need to examine the company's balance sheet to resolve it.
This is not meant to be an exhaustive list, but it is hoped that it will give you a good idea of why you should not base your investment decision on the share price. I never look at the price of a security alone when I invest, because I prefer to own a stake in the best company outside of 10,000 in the worst.
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Brendon Lau owns shares in BHP Billiton Limited. The Motley Fool Australian mother company Motley Fool Holdings Inc. owns shares in CSL Ltd. The Motley Fool Australia has no position in any of the securities mentioned. We Fools may not all have the same opinions, but we are all convinced that, considering a wide range of insights, we have become better investors. The Motley Fool has a disclosure policy. This article contains only general investment recommendations (with AFSL 400691). Authorized by Scott Phillips.
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