TRADERS, NEVER LET STOCK PRICES DECEIVE YOU
Do not judge a stock by its share price.
Not every stock with a small price is cheap. Not every stock with a higher price is expensive. Many investors are frequently deceived by this notion, which can lead to trekking the wrong path and making some bad decisions for their money. A stock that goes from $100 to $10 might end up at zero, and a stock that goes from $30 to $60 might double again to $60.
Majority of investors often commit the mistake at looking only at stock prices since this is the most visibly quoted number in financial news. But they do not know the factors behind its pricing. The stock’s actual price bears little significance unless many other factors are taken into account.
For instance, an investor needs to choose between two stocks. Company ABC has $100 billion market capitalization and 10 billion shares, while Company XYZ has $1 billion market capitalization and 100 million shares. Both are priced at $10, but Company ABC is worth 100 times more than Company B. Many retail investors may find a stock with a $100 share price intimidating because they think it is very expensive. They also think a three-digit price is not good but a $5 stock has better chance of doubling than the more costly stock. However, this is a misleading view. A $5 stock is considered overvalued, and the $100 stock undervalued. The opposite might be correct, too. But remember that share price alone gives no sign of value. Market capitalization gives a clearer indication on how the firm is valued.
Stocks are split into shares for investors and distinct units of the firm can acquire part of the entity relative to a portion of the total shares. Companies have differing number of shares outstanding. Stock splits and reverse stock splits are some methods of dividing the stocks. There are certain psychological explanations behind stock prices, and firms tend to take on this investor psychology through stock splits.
Stock Splits. The firm will modify each share of stock into two, meaning the value of every share will be divided into two. The two new shares will be identical to an existing share. For example, an investor might prefer buying the shares at $30, creating a $3,000 investment in order to purchase 100 shares. However, it lacks logic when looking at the actual transaction. When the investor decides to buy back the stock following this split, 100 shares comprise a $3,000 investment. But the investor can easily obtain 50 shares prior to the split, made the same amount of investment, and had the similar percentage ownership in that firm. Aside from the price itself, market cap is important. A company’s market cap won’t change because of the split, so if a $3,000 investment denotes a 0.001% ownership interest ahead of the split, it is still the same afterward.
Reverse Splits. The opposite of stock splits, it is a corporate action wherein the firm cuts the total number of shares outstanding. The move entails dividing the current shares by a number such as 10, meaning 1-for-10 split. Any combination may be used. It does not add any true value to the stock and create an investment in the firm more or less risky. In essence, it only changes the share price. For instance, if the share price declines to $12, the company can counter this by executing a 1-for-2 reverse stock split. On that note, the firm will convert each two shares of stock outstanding into one share worth $24 (2 x $12).
Share price can hugely affect a company. Basically, there are underlying factor beneath a stock’s price, as well as psychological and real implications, which can impact the solvency of a business. Investors, do not be fixed on the share price alone. Prices can move dramatically through reverse splits, stock dividends, and stock splits without altering fundamentals. So the next time you think about your investment, go beyond the stock price. Do not let the stock price fool you.
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