Why You Must Not Purchase Stocks Solely Based On Share Price

Before investing, you must carry out a full analysis, comparing likes with likes and ultimately determining which stocks are the best for your portfolio.

If you had to choose between purchasing a company’s stock at N15 per share or another at N150 per share, which one would you go for? For the new investor or the rookie financial person, purchasing a stock at N15 per share means there is more room for growth.

He or she would think that investing at N15 would mean that in a matter of years, it too would rise to N150 and maybe even higher, enough to enjoy all the gains from it. If you are part of the crew that thinks like this, then you are in for a big surprise.

Like me, you too would have heard stories of people who had the opportunities to purchase Bitcoin and when the price was still $1 and didn’t. You would have heard about those who had the opportunity to buy plots of lands in Lekki when it still went for N100,000 per plot in comparison to the millions of Naira it costs today.

So, indeed there is gain in buying when the price is low. However, there are so many factors involved in making this decision and price is only a very small part of the problem.

The first truth is that not all stocks grow. A stock at N15 could be at its peak while the one at N150 might just be starting its growth journey because of its amazing potentials.

As such, the fact that you’ve seen or heard of how some people amassed great wealth by investing in the right stocks at the right time does not mean you too would invest in any stock that is trading at a low price with the expectation that it would rise exponentially in just a few years to come.

Another thing you must understand is that with share price on its own, you are not equipped with enough information to determine which stock has the better growth potential. In fact, you don’t even have enough information to determine which stock is the cheaper one.

Just as you can purchase a cheap car and end up spending more money than you would have spent than if you had simply purchased a more expensive one, you need to carry out a level of analysis to determine which stock is cheaper bearing all relevant factors in consideration.

At this point, you would already know that when you purchase stocks, you are essentially buying a portion of a company’s ownership. You now own a fraction of a company.

As such, when you want to determine which stock is cheaper, you must do so in comparison with the value of the company as well as its outstanding shares. There are also situations where the company’s shares are overvalued or undervalued.

The price on its own also cannot reveal this. Rather, it must be compared to the earnings per share.

So, if the earning per share of the stock trading at N15 is N0.30 and the earning per share of the stock trading at N150 is N50, which would you go for? Put in perspective, a share in the N15-priced company gives you a price to earnings rate of 100 (N15/0.15) and a share in the second company gives you a P.E ratio of 3 (N150/50).

It means that you are paying N100 for every N1 in earnings from the lower priced company, while the other company is giving you the same N1 in earnings for just N3. You would think again wouldn’t you?

Yet, other factors like the growth potential of both companies still need to be considered. The idea is that before investing, you must carry out a full analysis, comparing likes with likes and ultimately determining which stocks are the best for your portfolio.

Written by Lawretta Egba.