Tuesday, August 14, 2012

Do stock prices matter?

Do stock prices by themselves have any impact on whether or not you should buy it?

TLDR: No.

As an example, consider the two stocks: General Electric and Berkshire Hathaway Class A.

Stock Ticker Price Market Capitalization
General Electric Company GE 20.99 221.63B
Berkshire Hathaway Inc. BRK.A 127,380.00 210.91B

As you can see, GE's stock costs less than 6000 times less than Berkshire Hathaway's, yet the two companies have about the same market value. The reason behind this is that GE has 10.56 billion shares outstanding while Berkshire Hathaway has a only 1.66 million shares.

Yet from a psychological standpoint, people will drawn more towards low priced shares. However, the raw share price has nothing to do with the market value of the company.

Does that mean the share price should be completely taken out of consideration when picking stocks? For most companies, the answer is yes. There are two cases where it does matter: when the share price is extremely high (e.g. BRK.A at $127,380) or extremely low (e.g. SPEX at $0.48).

In the first case, it's important because the share price may simply be so high that you cannot afford to buy a single share (there is no such thing as a fractional share). If you want a piece of Warren Buffett's BRK.A, you'll have to pay generously for even the smallest portion of his wealth.

In the latter case, the stock is considered a penny stock (less than $1). Many stock brokers charge an additional fee for trading penny stocks. This fee may cut significantly into your profits or worsen your losses.

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Obligatory Disclaimer

The author is not qualified to give financial, tax, or legal advice and disclaims any and all liability for this information.