Over the break I was talking to some of my friends who had some money saved from their summer internship. They were thinking about investing.
One of my friends was kind of annoyed because he could only buy a couple shares of Company A Stock but hundreds of Company B Stock. My other friend interjected and told him to look at Company A and saying, “Dude Company A’s Stock is doing good. What are you talking about? Look how high it is.” My friend (wrongly) thought that a stock with a high price meant that the company was doing well.
I told them to hold up.
I explained why stock prices don’t really matter. Look at these two companies, for example:
Market cap: $100 billion
Shares outstanding: 1 billion
Price per share: $100
Market cap: $10 billion
Shares outstanding: 100 million
Price per share: $100
Company A is 10 times bigger than Company B, but it has the same price per share. A company’s price per share is just some basic division of the market cap and shares outstanding.
Peter Lynch had a good quote explaining this. I’ll summarize it a little and add a little twist to it.
A Ferrari could be $150,000, which is expensive for me, but for a Ferrari that could be a steal. The Ferrari is a stock. The price itself doesn’t tell you if it’s a good deal—it just matters if it’s a good price in relation to other Ferraris. It could be the Ferrari 250 GTO, which sold for $52 million dollars selling for the $150,000. If so, then it’s a stellar deal.
So, it just depends on whether the stock price is selling cheaper than its intrinsic value. Stock prices basically rise if more people buy it then sell it, and stock prices fall if more people sell it than buy it. There are a lot of reasons why more people buy it then sell or vice versa, depending on the performance of a company, public perception and other factors. Value has little to do with price.
So, in case any of your friends have a similar argument, just set them straight, let them know that stock price has little to do with value or if the company is a good buy.
Adil Naqvi is a senior majoring in finance and supply chain management. He can be reached at email@example.com.
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