The price of a stock is one of the most confusing things about the stock market to a new investor. Why are some stocks available for such a low prices? And why are some stocks so expensive? Are cheaper stocks a better investment than expensive stocks because they have a high probability to rise? Questions like these make a new investor confused about their investment decision in the stock market.
To understand if low-priced stocks are better than high-priced stocks, there are a few questions which need to be answered. These are the most commonly asked questions by new investors about low-priced stocks.
- Are low-priced stocks cheaper than high-priced stocks?
- Do only small companies have low-priced stocks?
- Do low-priced stocks provide higher returns?
- Do you lose less money if you invest in a low-priced stock?
Let’s try to answer these questions one by one.
Are low-priced stocks cheaper than high-priced stocks?
Even though a stock which is priced at Rs. 10 looks cheaper compared to a stock which is priced at Rs. 10,000, this is absolutely not the case! The value of a stock (just like any other asset) is determined by the value of the asset. If a broken pen is available for Rs. 5, it doesn’t mean that the broken pen is cheap. A broken pen is worthless, so a worthless item which is available for Rs. 5 is actually very expensive. Similarly, a broken business has no value regardless of how low the stock price appears. Let’s consider an example for a moving out sale.
Let’s suppose that your neighbour is shifting his apartment and is having a moving out sale. He has two items left which are available for sale. The first item is a 3 month old sport cycle with 21 gears which he is offering at Rs. 5,000 (50% off from the market price). The second item is a coffee mug which he is offering at Rs. 150 (50% off from the market price). Let’s assume that you are in need of both items. So, you check out both items before purchasing them. You find that the sports bike is in a very good condition and looks brand new. The cup, however, looks very old and dusty. Which one will you prefer to purchase from your neighbour?
Almost everyone would purchase the sports bike from their neighbour at Rs. 5,000. It is clearly a better deal because you are getting an almost brand new bike at half the price. On the other hand, nobody would want an old mug for Rs. 150 even though a similar discount of 50% is offered on the item. Clearly, a low-priced item is not always better than a high-priced item!
Just like a sports bike and a coffee mug which are different items and have different prices, stocks are also different companies which are offered at different prices. If the stock of Company A is available at Rs. 500 and the stock of Company B is available at Rs. 20,000, you cannot make any conclusion by simply looking at the price of the company without looking at the business model of the company! Just like you checked the sports bike and coffee mug closely to decide your purchase, similarly you need to observe the fundamentals of both businesses to decide your stock purchase. So, a low-priced stock is not cheap compared to a high-priced stock!
P/E ratio (price to earnings ratio) is a famous fundamental analysis tool which is used by analysts to figure out whether a stock is cheap or expensive. Only P/E ratio (and not stock price) should be used by investors to gauge the “expensiveness” of a stock. To learn more about P/E ratio, visit this article!
Do only small companies have a low stock price?
No, the price of a stock has nothing to do with the size of a company. It is entirely possible for a small cap company to have a high price per stock. On the other hand, it is also possible for a large cap company to have a low price per stock. Here are some examples of companies and their stock prices.
| Low priced stock | High priced stocks | |
| Small cap company | RVNL (Rs. 31) | VST Industries (Rs. 2,950) |
| Large cap company | ITC (Rs. 232) | Nestle India (Rs. 17,400) |
*all stock prices are at the time of writing
It is quite clear that the price of a stock has nothing to do with the size of the company. A company like ITC has a small stock price, yet it is one of the biggest companies in India. Another example of a stock is MRF Industries which is one of the most “expensive” stocks in India, priced at Rs. 66,000 at the time of writing. However, many of you would be surprised to know that MRF is a midcap company, not a largecap!
Even though ITC has a small stock price, the total number of stocks for ITC is very high. On the other hand, even though MRF has a huge stock price, the total number of stocks for MRF is low. The size of the company has nothing to do with the price of the stock!
Do low-priced stocks provide higher returns?
There is a common belief amongst retail investors (especially new investors) that low-priced stocks provide better returns than a high-priced stock. Many investors think that it is easier for a Rs. 10 stock to double compared to a Rs. 10,000 stock. Let’s consider the story of two investors – Ram and Shyam.
Ram wants to invest Rs. 1 lakh in the stock market. He found a growing company called Bajaj Finance and decided to buy the stock. He bought the stock in March, 2017 for a price of Rs. 1120. The stock price has increased to Rs. 6918 providing Ram a return of over 6 times his initial investment. His investment of Rs. 1 lakh has turned to Rs. 6.15 lakhs!
Shyam also wants to invest Rs. 1 lakh in the stock market. He found a penny stock called Suzlon and decided to buy the stock just because it had a very low price. He bought the stock in March, 2017 for a price of Rs. 18.25. The stock price has decreased over 5 years to the current price of Rs. 10 per stock. This reduced Shyam’s initial investment of Rs. 1 lakh to Rs. 55,000 which is a loss of 45%!
It is quite clear that there is no guarantee for a low-priced stock to provide a better return than a high-priced stock. In fact, most stocks which have given a multibagger return in the past will have a high stock price. The return of the stocks are determined by the quality of the business, not by the price of an individual stock.
Do you lose less money if you invest in low-priced stocks?
No, you do not lose less money if you invest in low-priced stocks. Suppose you have Rs. 1 Lakh to invest in a stock. You can either buy 10 stock A (priced at Rs. 10,000 per stock) or 1000 stock B (priced at Rs. 100 per stock). If both stocks fall by 50%, you lose the exact same amount of money – Rs. 50,000 on your investment. It doesn’t matter whether the price of the stock is low or high. The profits and losses are measured in the stock market in terms of percentage (not absolutes), so the price of an individual stock doesn’t matter!
Conclusion
It is quite clear that a low-priced stock doesn’t mean that the stock is available at a discount. It also doesn’t necessarily mean that the stock will provide a better return in the future. Both small and big companies can have a low-priced stock and you can lose an equal amount of capital in a low or high priced stock. So, investors should not base their investment decisions on the basis of the stock price. A low-priced stock can perform well if the fundamentals of the company are great. Also, a low-priced stock can perform poorly if the fundamentals of the company are poor. The investors should focus on the business model of the companies, rather than getting enticed by the low price of a stock. To learn more about the steps to choose your first stock, visit this article! However, the final decision of investment depends entirely upon the reader.
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DISCLAIMER : I am not a financial advisor. I am not for or against any company which I have mentioned in this article. All the information provided here is for education purposes. Please consult a financial advisor before investing.
Contact me at investmentabshuru@gmail.com
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