Whether or not you are currently an investor you have almost certainly heard the phrase, “buy low, sell high.” Just in case you have not though, this phrase is commonly used to describe the basic investing strategy, that is, buying a stock while it is perceived to be trading at a low price (meaning you believe it is undervalued), and then selling the stock when it is perceived to be trading at a high price (meaning you think the valuation is correct or the stock is overvalued). That said, there is an important distinction between a stock that trades at a high price (or low price) and a stock that is overvalued (or undervalued).
For example, imagine there are two companies (A and B) that trade at significantly different prices. Company A costs $1,000 per share, while company B costs only $1.00 per share. Using this example, company B must be the better investment since the buyer is getting in at such a low price, right? Interestingly, that is not necessarily true. Without knowing additional information about each company such as: valuation ratios (including price/earnings ratio and price/sales ratio), or, other potential indicators like company history, sector, and relevant news, simply knowing the current stock price does not indicate future earnings (or losses). Despite this, there are some important differences between buying a low-priced stock (otherwise known as a “penny stock”) and a high-priced stock (often called a “blue chip stock”). Here are a few you might want to know:
Before investing in penny stocks, it is important to understand that they are known for being particularly volatile. For instance, it would not be unheard of for your investment to double, triple, or maybe even quadruple in a short period of time (perhaps even a single day). On the flip side, the extremely volatile nature of these stocks can also play against you, causing you to lose half, or even all, of your investment in the same amount of time. Generally, investing in higher priced stocks is much less volatile barring any type of extreme circumstance. Although, that does mean that an overnight boom is also less likely.
The ability to afford a share of an expensive stock used to be a notable barrier to entry for small investors who want to put their money in the stock market. As such, if an individual without a lot of disposable income wanted to buy a share of Apple (APPL)’s stock, which currently costs around $972 during the time of writing this, they were not able to. Luckily, this is no longer a problem because of the dollar-based investing system you can take advantage of through your DriveWealth app. Whether you want to spend $15 to own a fraction of a share of company A (from our earlier example) or purchase 15 full shares of company B, you now have the freedom to do so. Therefore, in that scenario, you might want to consider diversifying your portfolio between the two since you do have the option to do so.
A lot of the time, expensive stocks are expensive for a reason. The company trading for hundreds of dollars has likely proven itself in one way, shape, or form, which has given it value and increased investor confidence. Conversely, penny stocks might be newer companies or companies that have not yet proven their worth. Consequently, you could find that the larger companies are easier to keep up with and follow in the news because they simply make headlines more frequently and have a larger quantity of people following them (or using their products, services, etc.). Moreover, if you can closely follow the happenings of a specific company, it is much easier to make informed investing decisions. Ultimately, doing your due diligence is often the difference between a big gain and a big loss — with a higher flow of available information, the process is much simpler.
Now that you know a little bit more about the differences between higher-priced stocks and lower-priced stocks, besides just the cost, it is easy to see that the price of the stock does not really tell you how expensive the investment is. This is especially true now that you have the ability to use a dollar-based investing application, rather than needing to purchase full shares of stock each time you want to make a trade. Accordingly, it will almost certainly be more beneficial for you to focus on the value of the investment and not the sticker price. Remember, “buying low” means buying stocks that are undervalued and “selling high” is to sell when a stock reaches its peak value or becomes overvalued. If you truly understand this concept and how to apply it, you will be off to a great start!