Investors shouldn’t waste too much time focusing on a stock’s price. You’ll find that stock quotes don’t actually tell you much about whether a stock is cheap or expensive. Share prices don’t tell you how much of a stock you can afford.
Here are three reasons stock price doesn’t matter as much as we often think it does.
1. Stocks aren’t expensive based on share price alone
A $10 stock can technically be more “expensive,” meaning overpriced, than a $100 stock.
Consider Amazon (NASDAQ:AMZN), which is just under $3,300 per share, and Square (NYSE:SQ), which trades at $270. If you analyze the two, it’s easy to conclude that Amazon is actually cheaper.
When you’re purchasing a stock with cash, you have to think about what you’re actually buying. Stocks represent partial ownership of companies, and they indirectly entitle you to the future financial returns of that company. That’s why investors think about valuation as the price of stocks relative to different measurements of profit. Price to book ratio, price to earnings ratio (P/E), price to cash flow, and enterprise-value-to-EBITDA are different ratios used in this measurement.
Amazon has a 57.5 forward P/E ratio. Square’s forward P/E is 167. Amazon has 26.2 EV/EBITDA, and Square’s is 174. Amazon is also much cheaper relative to book value.
Even though one Amazon share costs 10 times as much as one Square share, a given amount invested in Amazon entitles you to more current profits. You might think that buying a new car for $40 is “cheaper” than buying a stick of gum for $25. In that same sense, the shares of different stocks aren’t necessarily equal. The quoted price doesn’t tell the whole story.
2. Share count (and price) can change overnight
A stock’s price is determined by supply and demand on the open market, but that price represents the value of the underlying company’s equity, divided among all the shares outstanding. The value of the company is the more important part of that equation because the number of shares issued in an IPO is somewhat arbitrary.
In fact, the number of shares outstanding can be drastically altered through stock splits and reverse splits, both of which are fairly common. When those occur, the number of shares changes overnight, and the price of each share changes proportionately. Meanwhile, the overall value of the company and its profits shouldn’t be changed at all.
Apple (NASDAQ:AAPL) executed a 4-for-1 split last year, which quadrupled the number of shares from one trading day to the next. Shares were roughly a quarter of their value the day before, but shareholders now had four times as many.
Share price is a tool for measuring market value, but it doesn’t provide all the information necessary to assess the value of the company and the status of your investment. If share count can change overnight without anything fundamentally impacting the company, then so can share price. See the full picture to analyze your investments.
3. Fractional shares are more popular than ever
You might not have $3,300 laying around to splash on a single stock like Amazon. Luckily, fractional shares have become common among most of the leading brokerage platforms.
Say you have $330 that you’d like to invest in Amazon. Many brokers will allow you to purchase 0.10 shares of Amazon. Instead of selecting a certain number of shares, then paying the corresponding price, most investors can now reverse that sequence. Pick the amount you want to spend, and you’ll get however much of a stock that can be purchased with that amount.
If you build a portfolio with fractional shares, then a company’s market cap is more important than a stock price quote. Of course, it’s still helpful to pay attention to a simple quoted price when you’re analyzing an investment, but you need to zoom out a bit to really understand what it means.
If fractional shares are an important feature for you, make sure your brokerage platform offers them.
Overall, all of this is not to say that stock prices are completely meaningless, but you have to put all of the stock information in context for it to be useful.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.
View more information: https://www.fool.com/investing/2021/08/14/3-reasons-stock-price-doesnt-matter/