Stock prices, especially for new investors, can be somewhat complicated. In reality, the price of a single stock doesn’t matter that much as one might think. In the end, the market cap is determined by the stock value times the number of stocks.
This means, that even if Company A shares trade at 100 dollars and have 100 shares total, and Company B shares trade at 10 dollars, with 2 000 shares, Company B is more valuable overall by market cap.
Company A 100$ x 100 = 10 000$ market cap
Company B 10$ x 2 000 = 20 000$ market cap
This also means, that even if “stock” seems cheap because it trades at 0,5 dollars, it doesn’t necessarily mean that. The company might have a billion shares, and be a really overpriced company, even if the stock price seems cheap.
Share price doesn’t tell the whole picture
Like you saw in the example above, stock prices don’t tell the whole picture. Even “cheap” stocks might be from a really valuable company. On the other hand, even if the stock seems expensive by price tag, the company overall might not be that expensive.
Let’s take two companies as an example. Berkshire Hathaway is trading at around 529 000$ per share, where Apple is trading at 174$ per share at the time of writing. Even though Berkshire shares seem really expensive, the company is only about a quarter the size of Apple, measured by its market cap.
There are also a lot more things that affect how expensive the company really is. Different financial key figures such as P/E and EBIT should not be ignored. Another big factor is the growth of the company and the industry.
In industries, that are growing fast in the following years, companies might be priced at very high already because of the expectations of investors.
Share prices don’t always follow the real price of the company
Another reason stock prices are irrelevant is that the price of the stock rarely projects the real value of the company. There are always over and undervalued companies, depending on who you ask.
If Apple stock fell 5% in a day, do you think Apple, as a company became 5% less valuable in just a matter of seconds? That is not the case. Apple might have not made any changes in the past month, yet the stock price could have fluctuated 10% in one direction, or another.
There are so many different factors that affect the prices of stocks. Some of them being fear, greed, and herd behavior. If people see stocks are falling, they can panic and sell, making the stock fall even further.
On the other hand, if the stock is rising a lot, FOMO (Fear of missing out) might hit. This way investors buy stocks that are already rising making it rise even further.
The actions of the companies do affect prices as well. I’m not saying they don’t. However, stock prices change daily, yet the company doesn’t announce news every day. The stock markets are not always representing the real value of companies.
What is stock split
So, why might one stock be more expensive than another, yet be less valuable as a company overall? That is where stock splits and reverse splits come into play.
Stock split means that if the company’s stock price is 5 000 dollars, for example, some people might not afford to buy that. The board decides to split the stock, 100:1, for example, where 1 stock becomes 100 stocks.
This doesn’t affect the market cap of the company. Every stock just becomes 100 new stocks, and the price of the stock should start from around 50 dollars. I have noticed that usually, when stocks split or announce splits, it might affect the price of the stock positively.
One reason behind this is that people realize that soon other people can buy those stocks as well, when one stock isn’t as costly. Also, if companies have to split their stocks, that usually indicates good performance in the past, since the stock price has grown so much.
Berkshire Hathaway for example, has never done stock splits, and that’s why it is trading at over 500 000$ per share.
What is reverse stock split
Reverse stock split means the exact opposite. If a stock is trading at 0,05$, they might announce a 1:100 reverse split, where 100 stocks are combined into one and the new price of the stock becomes 5$.
This happened to me once. I owned 850 stocks of Norwegian Air Shuttle, which was a losing position for me, and I have talked about it before as well. So, the company was going for a 100:1 reverse split, which ended me with 8 stocks of the company. 50 of my 850 stocks vanished. I had no idea that could happen, but it did.
To avoid situations like this, choose stocks that perform well. Norwegian Air Shuttle for me was a falling knife. Well-performing companies rarely do reverse splits. Companies who do reverse splits usually have not performed so well in the past.
Situations where stock price matters
The price of the stock can matter in some situations. One of them being that if the stock price is too high, not everybody can afford to buy the shares of the company. Well, it can be done with a broker that offers fractional shares, but not every broker has that opportunity.
Let’s take Berkshire Hathaway again as an example. I think it is a great company and I would love to own shares from it. However, since the stock is trading at over half a million dollars, with my current financial situation, I cannot afford to buy one yet.
Companies who have done splits have made it possible for people with lower purchasing power to own their stocks as well. This was the first thing why stock prices can have an impact.
Another reason is that mutual funds and institutional investors may choose not to buy stocks under 5 dollars. There are no rules that they couldn’t buy them, but they usually stay away from stocks trading below that price.
So, does the stock price really matter? The answer is that it doesn’t matter as much as new investors might think. There are some things where the price could have an impact, but the price doesn’t really tell us much about the performance of the company.
Look at other key figures to find out how valuable the company really is. If the stock is just a few dollars, that might not mean it is cheap. On the other hand, even if the stock price is 500 000 dollars, it is not necessarily an overvalued company.
Other investing-related posts can be found here.
Hopefully this was helpful to you, have a nice day.
This is not investing or financial advice. Always do your research before risking your hard-earned money. Past returns of the market are not a guarantee of future returns.