Everybody loves a bargain. But when it comes to investing, a cheap or laggard stock may not be the best deal. You could very well end up getting what you paid for.
“Many investors can’t resist $2, $5 or $10 stocks, but most stocks selling for $10 or less are cheap for a reason,” IBD founder and Chairman William O’Neil wrote in “How to Make Money in Stocks.” “They’ve either been deficient in the past or have something wrong with them now.”
Perhaps the company continually misses earnings or sales estimates, or shows shaky fundamentals. Lower-priced stocks also carry more risk because they often feature less dollar-based trading liquidity and big spreads between the bid and ask prices.
Better to buy fewer shares of an institutional-quality stock that’s rising soundly, rather than thousands of shares of a cheap stock. In the IBD 50, which you can access by hovering over the Stock Lists tab at Investors.com, you’ll see stocks trading at prices of 30 a share or higher.
Top mutual funds and other big players prefer companies with sound earnings and sales track records, and share prices of at least 15 on the Nasdaq and 20 on the NYSE. They tend to favor stocks that trade at least 400,000 shares a day, which allows funds to make trades with less impact on the share price.
Let’s take a look at Joe’s Jeans, a maker of high-end jeans and other apparel. In February 2007, the former Innovo Group announced plans to acquire Joe’s and change its company name. At the time, the stock was trading below 1.50 a share.
It rose as high as 3.60 in April 2010, as double-digit sales growth fueled the premium denim trend. But by mid-November 2011, the stock was back down to 50 cents. While money could have been made, one had to be nimble and accept higher risk.
Joe’s broke out of a sloppy 11-month base in February 2013 but didn’t get far. It pulled back to start work on a poorly formed double-bottom base. This one had two down weeks in heavy volume (1) and no up weeks in above-average turnover until the week ended July 12, forming the base’s right side (2) in just one week.
The second leg of the double bottom formed mostly below the 10-week moving average, a red flag (3). The next week after the stock’s breakout, Joe’s reversed badly, falling 28% in its biggest weekly volume in years (4). It sliced through its 10-week and 40-week moving averages.
The culprit? Its second-quarter earnings and sales disappointed Wall Street. Shares have since fallen as much as 50%.
(Editor’s Note: This story originally ran in the Jan. 8, 2014, edition of IBD. Sequential Brands (SQBG) bought Joe’s Jeans in September 2015.)