Dan,
As resident MRVC guru, I'm sending this to you - but opening it up to anyone who wants to comment. The author here stresses the advantages of higher-price stocks, but I think he really means stocks with higher visibility. And I'm wondering whether some of the factors he discusses won't continue to plague incognitos like MRVC (particularly the one about attracting institutional $). Thanks in advance.
INVESTORS CORNER
Cheap Stocks: You Get What You Pay For
Date: 11/18/96
Author: Leo Fasciocco
You have a choice between two stocks. Both look good. Both are profitable and have promising products. One
sells for $5 a share, the other $50.
Which would you buy? The inexperienced investor would love to buy the low-priced stock. He thinks a $4 or $5
stock will have a good chance of reaching $20 or $25 and he'll make a bundle. And compared to a $50 stock,
he's saving money.
The smart investor knows better. He knows the odds of a profitable trade are in his favor if he goes with the
high-priced stock selling at $50 a share or even $60 or $70. High-priced stocks that do well can move up to
$100 or $120, split 2-for-1 or 3-for-1, and run back up again.
Moreover, cheap stocks have huge transaction costs.
This year, many high-priced stocks have rewarded their holders handsomely.
International Business Machines Corp. has soared from 88 to 134 this year. Compaq Computer Corp. has
climbed from 38 in March to 75. HFS Inc. surged this year from 42 to 74, adjusted for a 2-for-1 stock split.
On the Nasdaq, Microsoft Corp. soared from 87 to 142 this year, Intel Corp. from 56 to 124, Tellab Inc. from
37 to 86 and Ascend Communications Inc. from 37 to 73.
Granted, some low-priced issues have done very well. But, the odds of a highly profitable trade favor the
high-priced stock. For every low-priced stock that may have worked, many others have failed.
This year analysts have noted ''a Nifty 50'' mania. That's a reference to the early 1970s when money poured into
a narrow group of high-priced stocks and drove them higher and higher.
High-priced stocks tend to attract institutional money. The reason is that funds find those stocks liquid. They can
put large amounts of money into them easily - and get out when the need arises.
Low-priced stocks, in contrast, don't attract many institutions. Many mutual funds, for instance, have a minimum
price limit or require a large minimum investment for each stock. The small stocks are not liquid enough to be a
feasible trade for them. Thus low- priced stocks often have only a retail, or small-investor, following.
Quality of sponsorship is crucial. Institutional buyers have deep pockets. They can drive a stock higher for a
sustained period of time. However, the retail crowd is usually speculative and flighty.
High-priced stocks are usually of better investment caliber, said Michael Metz, chief investment strategist at
Oppenheimer & Co. Also, a low-priced stock, he notes, is not necessarily cheap. Often, they have no earnings
and no dividends. So, they can be more expensive in terms of what you get for your money.
Metz said the market is placing a premium on quality of earnings forecasts and liquidity. The dominant investors in
the U.S. markets are not individuals coming in directly, but rather savers investing via mutual funds, he said. The
market is responding to pools of money.
A portfolio manager who runs billions will not buy a stock with a small dollar value because it has implications of
secondary quality. A lot of professional portfolio managers are sensitive to perceptions. The real question is, What
are you getting for your money? For every opportunity with a low-priced stock, there are at least 10 traps.
A.C. Moore, senior investment strategist at Dunvegan Associates of Santa Barbara, Calif., believes buying the
high-priced stock is the better strategy. ''The high-priced stock is usually more seasoned,'' he said. There is
greater probability it will be a high-quality issue.
Moore also notes, ''The spread, from bid to ask, is usually much higher on a low-priced stock versus a
high-priced stock. Also, commissions are higher. That's a tremendous burden an investor has to overcome when
buying a low-priced stock.''
As an example, if one were to put $10,000 into a $5 stock, one must buy 2,000 shares and pay a commission of
$80 to $120. However, if one were to spend $10,000 on a $50 stock, he would buy 200 shares. The
commission would be only about $30. The same cost saving would show up on the sale.
In addition, the low-priced stock will sell at a spread of say 5 bid and 5 1/4 ask. That additional 25 cents a share
works out to an additional cost of 5%. For 2,000 shares that would be an expense of $500.
On the other hand, the high-priced stock may sell at 50 bid and 50 1/4 ask. On a 200-share purchase, that
spread amounts to only an extra $50, or 0.5%. The cost savings on the high-priced stock are obvious.
In reality, the ''cheap- priced stock at $5 is actually more expensive to buy'' costing as much as $1,240 for a
round trip after commissions and spreads. That compares with up to $160 for the high-priced stock.
Another disadvantage to a low-priced stock is volatility. A 1/4- or 1/2-point price move in a $5 stock represents
a big percentage change. Not so with the $50 stock. That means an investor in the low-priced stock can easily
find himself trapped in a 20% loss if the $5 stock declines just one point.
The $50-priced stock can swing 5 or 6 points over a few days, and an investor can still have a handle on the
situation and have time to get out with a small loss.
''There is a tendency among investors to try to get the edge on others by buying something that is not well
known,'' Moore said. ''But, on Wall Street there is very little that is not known. The difference between a
successful and unsuccessful investor is the ability to step up and buy a stock even if it sells at a high price.'' |
