Dear DTA,
I sometimes see recommendations for really expensive stocks. I’m trying to buy cheap stocks because I don’t have a lot of money. Stocks under $10 per share. Why do some trades recommend stocks trading over $100? Aren’t they too expensive?
-Emily R.
Hi, Emily.
Thanks so much for writing in. It’s genuinely a pleasure to hear from our readers.
Your question is actually not that uncommon.
A lot of people who are new to investing get tripped up by the misconception that stocks with lower price tags are cheaper – and thus better – to buy.
That means a stock that’s priced at $5 is automatically better than a stock priced at $50.
The latter is 10 times as expensive in price terms, which makes it a poorer investment.
But I just want to make something very clear.
This is incorrect.
An investor has to retrain their brain on this a bit.
When you think about cheap and expensive, you have to think in valuation terms.
It’s not about price, per se.
It’s about price relative to value.
A stock with a low price is not automatically cheap, nor is a stock with a high price automatically expensive. And vice versa.
Warren Buffett, arguably the greatest investor to ever live, put it best:
“Price is what you pay, value is what you get.”
I’ll give you an example to illustrate this point.
Let’s say you find a business out there with a market capitalization of $100 million.
This business has 10 million shares outstanding.
That would mean each share has a price of $10 (100 million/10 million).
Now, let’s say this company decides to execute a stock split, which would double the shares outstanding.
Well, the outstanding share count would go from 10 million to 20 million.
Guess what happens to the stock price?
The market adjusts this to reflect the new reality of the math.
That $100 million market cap now gets divided across 20 million shares, thus re-pricing each share at $5.
So the stock is now cheaper in price terms than it was before, but the value of each share is also lower.
You have to buy two $5 shares in order to get the same equity percentage of the business as one $10 share offered before.
There are 20 million slices of the same pie, compared to only 10 million slices before.
The pie hasn’t changed in size or value, but the size and price of each slice changed.
I’ll give you another example.
You spend time looking at a business and conclude that each share is worth $50, but the stock is only priced at $40.
Simultaneously, you spend time looking at a different business and conclude that each share is worth $25, but the stock is priced at $30.
Which one is the better investment?
It’s very clearly the first stock.
The first example has a $40 price tag, while the second stock has a price tag of $30.
So the latter has a lower price in dollar terms, but it’s absolutely not the better investment.
At least, not based on the information we have here.
That’s because the first example is worth more than the second example. Much more. Certainly more than the difference in price.
There’s a $10 delta in price.
But the delta in value is $25.
It’s almost like going into a grocery store and automatically shunning the filet mignon at $15 pound, because the ground beef is priced at $3/pound.
You can’t compare a burger to a steak. One is worth more than the other.
Now, while there might be a great measure of subjectivity when comparing a delicate cut of high-quality tenderloin to a pile of ground beef, valuing businesses tends to be much more objective.
That’s because you’re largely relying on math.
Valuation is so important.
Routinely buying undervalued high-quality stocks can lead to amazing long-term investment results.
And we do our best to give you the right resources to help you on this front, Emily.
I can tell you that I’ve personally relied on the dividend growth investing strategy to become relatively wealthy at a very young age.
This strategy is so powerful, it helped me retire in my early 30s!
I share with you exactly how I went about doing that, via my Early Retirement Blueprint.
By living below my means and routinely investing my excess capital into undervalued high-quality dividend growth stocks, I was able to build my FIRE Fund.
That’s my real-life, real-money portfolio. And it generates enough passive dividend income for me to live off of.
Fellow contributor Dave Van Knapp’s Dividend Growth Investing Lessons will give you plenty more information on what this strategy is, why it’s so wonderful, and how to successfully execute it.
You should definitely educate yourself about this strategy, which will help correct the way you look at price and value.
Once you have a great handle on all of this, you can check out all of the amazing investment ideas we freely share.
I personally highlight a compelling long-term dividend growth stock idea every Sunday.
These ideas are presented in the Undervalued Dividend Growth Stock of the Week series.
Each stock undergoes a rigorous analysis and valuation process, which includes valuation opinions from professional equity analysts.
I filter these ideas from the amazing Dividend Champions, Contenders, and Challengers list.
That list contains invaluable data on more than 800 US-listed stocks that have raised dividends each year for at least the last five consecutive years.
There are many blue-chip stocks on that list.
These are some of the most profitable enterprises on the planet. That’s why they can fund these big, growing, cash dividend payments to shareholders.
Make sure to build up your knowledge base by consuming some quality content.
This will help you become a more educated investor, Emily.
Knowledge is power. Use that to your advantage.
And make sure to start today.
I wish you luck and success.
Jason Fieber
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Disclaimer: Jason Fieber is not a licensed financial advisor, tax professional, or stock broker. Please consult with a licensed investment professional before investing any of your money. If your money is not FDIC insured, it may decline in value. To protect the privacy of our readers, any names published in this article are under aliases. In addition, text may be edited, omitted or paraphrased for grammar or length.