Something I’ve always found interesting is the way investors look at stocks trading in the triple digits versus those trading under a dollar. They see a stock like Alphabet Inc (GOOG, GOOGL) selling for more than $750 a share and think it’s far too expensive for them to take a position in. Then they see cheap stocks like Groupon Inc (GRPN), which trades at under $5 a share, and are like, “Hey, I can afford to load up on that!”
That’s one way to look at it, but it’s not the right way.
Sure, if you have $800 to invest, you can only buy one share of GOOGL, but you could buy more than 200 shares of GRPN. However, in reality, I think this is one of the biggest mistakes an investor can make.
All too often I see investors loading up on way too many cheap stocks. And I’ve found that many would rather purchase the 200 shares of GRPN than the one share of GOOGL. Don’t get me wrong, there is certainly a place for low-priced stocks, but it’s very important to keep in mind that price doesn’t denote value. The fact of the matter is that having a lot of shares of a lousy company doesn’t make it more valuable than just one share of a great company.
My biggest concern is that investors who focus too much on cheap stocks probably are not properly diversifying and taking risk into account. Some people think diversifying simply means owning several different stocks, but really, there’s a lot you need to keep in mind, including industries, geographic regions and, yes, even market capitalization. If stocks under $10 make up more than 15% of your portfolio, you are likely taking a chance that isn’t worth the risk.
Second, you don’t need a lot of shares to make money, even though that’s a widely accepted notion. Say you had $6,000 to invest on the first trading day of 2009, right in the middle of the last recession. There were plenty of stocks trading in the single digits, and you could have picked one and bought hundreds of shares. Well, lots of cheap stocks either bit the dust or simply pulled back to even lower prices.
On the other hand, if you had bought just 19 shares of Alphabet (which was Google back then, trading under the GOOG ticker) with that $6,000, your investment would have nearly doubled to almost $12,000 just one year later.
The Real Risk With Choosing Cheap Stocks
The key is in the percentage change.
If you had happened to put that $6,000 in a low-priced stock that also doubled in a year (although the odds of that happening were much less than the chances that Google would double), you would still have walked away with $12,000.
“Cheap” actually has nothing to do with share price or stock charts. Stocks are often cheap for good reasons, so you really need to do your research before loading up on a company that’s trading below $10. There is absolutely nothing wrong with buying low-priced stocks from time to time, but please do not overweight your portfolio in them or think they’re a quicker path to building wealth.
One of my Twitter followers recently asked me if it was a good idea to hire someone to teach him about penny stocks. My response? I’d prefer he bought just one share of a $100 stock.
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