Does the price of a share of stock indicate its upside potential? Can I make more profit with a $12 stock than I can with a $56 stock?
These questions cannot be answered in a vacuum, so let’s look at contributing factors.
First of all, stocks do not go up and down because of price point. Stocks go up and down for two reasons: investors like the prospects of a company and buy the stock, thus driving the price up, or they dislike the company’s outlook and sell the stock, thus driving the price down.
While there are investors who buy modest numbers of shares in low-priced stocks, the larger number of shares traded each day are bought and sold by investment firms, mutual funds and other entities that would never make buy and sell decisions based on share price alone. They look at the fundamentals, meaning sales, profit, debt, products, competitors and the like; or technical indicators, meaning price charts, volume of shares traded, etc., neither of which has anything to do with whether the stock costs $12 or $56.
So the big thing we glean here is that if professional investment companies are not making their decisions based on the price of the stock, neither should you.
If we have two companies with the same exact sales and profit and products and future outlook, essentially, if all factors are equal, then the lower-priced stock will be more of a bargain and have more profit potential for the investor. But the reality is that when you look at the earnings per share of a $12 stock, the number is usually far below $1.00 per share, while the earnings per share (EPS) of a $56 stock might be $3 or $4 or $5.
EPS is a number that helps you compare apples to apples. This number takes the company’s annual net profit and divides it by the number of shares of stock which are outstanding. Generally speaking, a stock with EPS of $4.25 is going to command a much higher share price than a stock with EPS of $0.63.
An even easier way to look at the stock price vs. the EPS, and make a guess as to whether you’re getting a good value for your money, is to look at the price/earnings ratio (P/E).
• A $15 stock with an EPS of $0.50 has a P/E of 30.
• A $40 stock with an EPS of $4.00 has a P/E of 10.
Generally speaking, a lower P/E indicates lower risk to the share price. So you’re really not comparing a $15 stock to a $40 stock in this scenario. What you’re comparing is a stock with a high P/E of 30 to a stock with a low P/E of 10.
If you look at a chart of Whirlpool’s (WHR) stock price in 2014, you’ll see that the stock traded sideways between 133 and 160 through October. But then the stock had a huge run-up. It rose 51% from the October 2014 low through the February 2015 high. What caused the run-up? Whirlpool’s EPS outlook had been deteriorating in 2014, from expectations of 25%+ growth, down to expectations of 14.9% growth. Now certainly 14.9% is a good earnings growth rate, but the bigger point is that the market had been expecting more, so the share price stagnated all year. Then, beginning in late October, earnings estimates for Whirlpool began rising for both its 2014 and 2015 fiscal years. Boom! The share price took off! Earnings estimates rose and rose until early February, when suddenly, expectations again began a series of downward revisions, largely due to adverse currency impacts on earnings.
It’s no coincidence that earnings expectations moved exactly in line with the share price. Lots of investors would consider Whirlpool to be a “high-priced stock,” and avoid it. That’s a shame, because I’ve seen Whirlpool make stock price moves of 50% to 100% four times since January 2012, always based on EPS trends. That’s why I spend so much time talking about EPS and valuation. I literally do not look at a stock’s price when I’m researching a stock. The price means absolutely nothing to me until I know how the earnings, balance sheet, P/E and price chart look. Only at that point can I make a decision on whether to buy the stock.
To me, price is just a random number, but valuation is everything.