A common misconception among investors and traders is that a stock at $5 per share is "cheaper" than a stock trading at $500 per share. This seems to be common sense, but in reality, it just isn't true.
Many investors, particularly newcomers to the world of trading, are tempted by the allure of a "cheap" stock trading at under $10, failing to realize that the stock may not be cheap after all.
For many, this lesson is learned the hard way - through the loss of hard-earned money. Here are some simple concepts and examples illustrating what actually makes a stock "cheap."
Stock Trading Myth #1: All Stocks Are Created Equal
The idea that a stock trading for a triple-digit share price is more expensive than a one trading for less than $10 is one of the most persistent, and yet completely baseless of all trading myths.
On the surface, this stock trading myth makes perfect sense. After all, a bottle of wine that sells for $280 is undoubtedly more expensive than a bottle of the same size that sells for $2. Sure, you would expect the $280 bottle of wine to be of higher quality, but that's a matter of personal preference, not fact.
The fact of the matter is that the two bottle of wines are equal in terms of size, but not in terms of price - one is expensive and one is cheap.
When it comes to trading, the difference is that not all shares of stock are created equal. They are, in fact, not all the same size. If a company has a total of 1 million shares of stock outstanding, and you own 100,000 shares, you own 10 percent of the company.
If another company has a total of 10 million outstanding shares, and you also own 100,000, you own just 1 percent of the company. Unlike the two 750 ml bottles of wine, these two stocks are not equal in any way.
Stock Trading Myth #2: Sirius Is Cheaper Than XM
Take the example of Sirius (SIRI) and XM Satellite Radio (XMSR). Sirius trades for around $5 per share and XM trades at $15. On the surface, it would seem as though XM were three times as expensive as Sirius, but upon closer inspection, Sirius is clearly the more expensive of the two.
This is because XM has around 258 million total shares outstanding, whereas Sirius has 1.4 billion. If you owned 10 million shares of XM, you'd own approximately 4 percent of the company, whereas if you owned 10 million shares of Sirius, you'd own less than 1 percent of the total shares.
Neither Sirius nor XM have made positive earnings (profits) as of yet. Sirius had annual sales of $325 million in 2005, whereas XM had sales of $663 million.
Per share, this equals sales of about $0.24 per share of Sirius. XM had sales per share of $2.88. Since the share price of Sirius is about 1/3 that of XM, it would be fair to multiply Sirius's results by three.
Even making this adjustment, $15 of Sirius stock earned sales of just $0.72 in 2005, whereas $15 of XM stock earned $2.88. XM is, by all reasonable measures, much cheaper than Sirius.
Do you see the insanity of thinking that Sirius is cheaper just because its share price is lower? A stock trading at a low share price is not necessarily cheap. A stock at a high share price is not necessarily expensive.
The above example used sales data because neither company has turned a profit as of yet. Normally, earnings (profits) data would be used to determine the stock's P/E (price-to-earnings) ratio.
Conventional wisdom says that a stock at a lower P/E ratio is cheaper than a stock trading at a high P/E ratio, and in this rare case, conventional wisdom is correct. But anyone who says that a stock at a lower P/E is a better value than a stock trading at a higher P/E takes the conventional wisdom too far.
Just think of the wine example: Some $2 wine might be as good as some $10 wine. In this case, the $2 bottle is a bargain. But some, if not most, $2 wine is cheap for a reason. The same is true for a stock at a low P/E ratio.
Stock Trading Myth #3: Low P/E is Good; High P/E is Bad
The key to making money on a stock is to find a stock at a value. Mere share price is not enough information. P/E ratio, income statement and balance sheet data, and technical chart patterns are the tools of true stock trading pros.
First and foremost, though, novices must overcome popular trading myths that only inhibit stock trading success.
Everywhere you go, you hear the same sad things: "The rich are getting richer while the poor are getting poorer." "There just isn't enough to go around." "It takes money to make money." This can lead you to believe that there is some mystical force out there that regular people like you and me just can't tap into. If you subscribe to this way of thinking long enough, you may be tempted to say, "Since it takes money to make money and I have no money, then what hope is there for me?" There is plenty of hope, as long as you don't listen to the wrong people. Media naysayers are definitely the wrong people.
You may have heard discouraging words from the media regarding the plummeting values and rising prices of property investments. Like many people, you may consider success in real estate to be an utterly impossible goal in today's economy. If this is the case, however, you've been listening to the wrong people; in reality, people are making money in real estate right now, and you can too, if you listen to the right people.
Sounds easy doesn't it? Yes it does. That's because it is. It is very easy to find a person who knows how to make money by investing in real estate, find out what has worked for them, and apply it to your own life. If it's so easy, you might be tempted to say, then why isn't everyone doing it? And that, my friend, is the meat of the matter. Everyone isn't doing it for two reasons. The first reason is that they've simply been told all their lives that success is very, very difficult. In fact, they've been told, because of the scarcity of money, success is almost impossible.
Most people are scared of trying to make money, based on cynicism and negative hype.
The other reason most people aren't making a fortune on the real estate market, is that it's just so simple. The people who find great success in property investing are the ones who learn a logical system and stick to it. A systematic approach is reliable, but it's also dull, and that's why so many people forego the obvious, proven methods of making money, and get tripped up on complex, esoteric moneymaking scams. These sorts of schemes may seem more fun and dramatic than gradually building wealth through proven methods, but the problem is that they simply do not work.
Sensationalism is a proven way to appeal to basic human nature, and that's why, rather than informing people about the tried and true ways that money can be made, the news media instead focuses on scaring the average Joe into believing in a grim picture of how the world works. With this kind of negativity on display on television and in print, it's no surprise that many see the world as a bleak place, where it is next to impossible to get ahead.
Luckily, this cynical viewpoint on the real estate market is not an accurate one. Not by a long shot.
If you aspire to success in the world of property investing, it's essential that you listen to those who have experience in the game, those who know the ropes and can teach you what you need to know. Consulting these people will help you to develop the systematic plan that you will follow to financial success. The key is not to get suckered in by proclamations of gloom from the news media, but rather to understand that you do have the potential to succeed, and to learn the proven strategies from those who have come before you.
Both William Smith & Alexandria P. Anderson are contributors for EditorialToday. The above articles have been edited for relevancy and timeliness. All write-ups, reviews, tips and guides published by EditorialToday.com and its partners or affiliates are for informational purposes only. They should not be used for any legal or any other type of advice. We do not endorse any author, contributor, writer or article posted by our team.
William Smith has sinced written about articles on various topics from Investments, Network Marketing and Baseball. William Smith the author provides additional financial information on many subjects as well as the secret to his success in the market along with 5 Free power stock picks emailed daily so grab your Free subscription on his website at. William Smith's top article generates over 90500 views. to your Favourites.
Alexandria P. Anderson has sinced written about articles on various topics from self improvement and motivation, Finances and Investing and Trading. Alexandria P. Anderson is a licensed Minnesota Realtor that uses the to help her clients to find and purchase. Alexandria P. Anderson's top article generates over 14800 views. to your Favourites.