Taking a Sledgehammer to Low-Priced Stocks

Recently, an investor told me that he prefers low-priced stocks. I’ll call him John … because his name is John.

Like hundreds of investors whom I’ve spoken with, John is concerned that he cannot earn the same profit on his principal in a high-priced stock than he can with a low-priced stock. I can’t answer that concern with a brief math equation. I can only use my anecdotal experience.

Stocks move up and down in percentages, not in dollars. Like most of you, I’ve got a stock quote app on my phone. I can ask it to report intraday stock movement to me in dollars, percentages, or volume. I only look at the percentages. I don’t look at volume, because it doesn’t figure into my stock analysis. And I don’t look at dollar movement, because it doesn’t tell me anything useful.
Within the app, I’ve got stocks grouped by industry. If I’m scrolling through the housing stock quotes, and I see +$0.20, +$1.35 and +$5.00, I’ll know that housing stocks are up today. Ok, great. But what if I had the app tell me percentages instead of dollars?

If I scroll through the housing stock quotes and I see +0.50%, +0.75%, +0.65% and +4.50%, I will immediately know that something unusual is happening with the fourth stock. That’s because industry groups tend to move up and down together—day by day, their stocks move in similar percentages. For example, at this exact moment, I’m looking at four biopharmaceutical stocks on my phone. They closed up 0.31%, 0.30%, 0.20% and 0.35%. Their share prices range from $66 to $293.

An investor who put $10,000 into each of those stocks in the morning saw each investment rise in value between $20 and $35 that day. Stocks move in percentages, not in dollars. No matter whether a person bought one share of a $10,000 biopharmaceutical stock that day, or 1,000 shares of a $10 biopharmaceutical stock, they essentially made the same profit on both investments.

Focus on the goal. The goal is not “how many shares can I own?” The goal is “how much profit can I make on this chunk of invested capital?”

You can’t outperform the industry group by buying the low-priced stock within the group. But you can outperform the industry group by buying the undervalued stock, with strong earnings growth and a bullish chart. Those three features are a thousand times more critical for people who are seeking capital gains than a random share price ever will be.

Let’s look at stock prices in another way. Investors get all excited over stock splits. Corporations are aware of that fact, and so sometimes they split their stocks in order to generate good will. It’s just a feel-good ploy. Logic tells us that if stock splits actually enhance share-price gains, then companies would constantly be splitting their stock prices to cause them to grow, and high-priced stocks wouldn’t even exist!

I know that I’m throwing bombs all over commonly held beliefs. Stock investing is rife with misconceptions. Believe me, I had misconceptions over the decades, too. But I’m wildly logical, and I forced myself to study these things, to find truth, and to improve my stock investing success.

For many years now, I NEVER look at a $200 stock as expensive or a $20 stock as cheap. I cannot know if those are expensive or cheap until I examine the numbers and charts. A share price can’t tell me anything useful. But fundamental and technical analysis tells me literally everything I need to know about a stock. I don’t need to know the share price, what kind of product the company manufactures or whether they emerged from bankruptcy three years ago. I just need balance sheet numbers and charts, and with those two things, I can consistently outperform the markets.

Believe me, if share prices mattered, I would know it. If I were wrong on this whole topic of low vs. high share prices, I wouldn’t be outperforming the markets! If I believed that there was any kind of advantage in owning lower-priced stocks, I wouldn’t own Alphabet (GOOGL), which I’ve owned longer than any other stock.

If I’m making you uncomfortable, then you don’t want to read these next paragraphs. Not only did my 28 years of stock investing help me figure out that high-priced stocks can earn big capital gains, but I also learned that low-priced stocks carry more risk, yet do not carry an increased reward. Time and again, I’d own stocks in the $10 to $17 price range, and one day they’d plummet without any news available. Then they’d take forever to rebound … or they’d fall farther.

You know what? That never happens with higher-priced stocks. When a $50 stock or a $300 stock, falls suddenly, you know exactly why it fell because it’s all over the news and research reports.

I finally came up with a rule for myself, to avoid this trouble: I don’t buy stocks that have price support below $18. Period. Ever. Again, if I were wrong about this, I wouldn’t be outperforming the stock markets, year in and year out.

I’m not saying that YOU CAN’T make money in low-priced stocks. I’m saying that I CAN’T make money in low-priced stocks. I’m going to stick with my strategy because it works. I’d love it if you’d join me, stretch your comfort zone and increase your capital gains.

And thank you, John, for being my guinea pig today. Please send more questions to crista@cabotwealth.com.

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