As a financial advisor I give stock quotes all the time. A stock quote is just the price for a share of a company’s stock. But, besides telling us how much we will pay for a stock, what does this price mean? How we get to the prices is a topic for another day. Today, I want to look at what a stock’s price can and cannot tell us.
A stock’s price, at its core, reflects the valuation of the company. A company’s value, a.k.a. market capitalization (or market cap), is quickly calculated as the number of shares outstanding multiplied by the price per share. But, the price itself cannot tell you how much a company is worth. For example, if a company is worth $1 million and has 10,000 shares of stock outstanding, then the share price would be $100 (100 x 10,000 = 1,000,000). If another company is also worth $1 million but has 100,000 shares outstanding, then the share price would be $10. These two companies have the same value even though the share price is drastically different.
This leads us to a widely believed stock market myth: stocks splits increase wealth. When a company splits its stock, it distributes additional shares for each share an investor already owns. For example, in a two for one stock split, each investor will receive one additional share for each share of the company they already own (they will now own two shares for every one). However, when this happens, the share price will drop by a proportionate amount. In this case, the price will drop in half. So, instead of owning 100 shares of a $50 stock, you will now own 200 shares of a $25 stock. As you can see, the total value is $5,000 in either case. There is no financial benefit to the investor due to a stock split.
I have found that a common misconception when it comes to stock prices is that higher means more expensive. This is not necessarily true. A stock’s price without any other information cannot make this assertion. It doesn’t matter whether you buy 10 shares of a $1,000 stock or 200 shares of a $50 stock. Both are investments of $10,000. It’s all about percentages. Owning $10,000 of a $1,000,0000 company is a 1% ownership stake regardless of how many shares you own (or at what price).
Also, expensive often implies overvalued. Whether a stock is overvalued will depend on a number of factors such as earnings per share*. This is where the price to earnings (P/E) ratio^ comes into play. A company with a $2,000 share price that earns $200 per share has a P/E of 10 (2,000/200), while a company with a $10 share price that earns $0.50 per share has a P/E of 20. All things being equal, it may be cheaper to pay 10 times earnings v. 20 times earnings**.
When I first started in this business, it was very common for stocks to trade between $20 and $80 per share. Triple digit share prices were few and far between. Stock splits were all the rage. Nowadays, it is not uncommon to have shares trade in triple or even quadruple digits. It almost seems like companies aspire to that. But that doesn’t necessarily mean that those stocks are overpriced.
A good way to think of it is like buying a car. If I offered to sell you a car for $5,000 would you buy it? Probably not right away. You would have questions, like what kind of car? How old is it? Does it run….? It’s the same for stocks. It is important to know what you are buying. There are many elements that determine whether a company is overvalued or undervalued. And the price can only tell you so much.
*Earnings per share is the total amount earned by a company divided by the number of shares outstanding
^Price to earnings ratio (or P/E) is the share price divided by the earnings per share
**The price to earnings ratio by itself also cannot determine if a stock is expensive
*Non-deposit investment products and services are offered through CUSO Financial Services, L.P. (“CFS”), a registered broker-dealer (Member FINRA/SIPC) and SEC Registered Investment Advisor. Products offered through CFS: are not NCUA/NCUSIF or otherwise federally insured, are not guarantees or obligations of the credit union, and may involve investment risk including possible loss of principal. Investment Representatives are registered through CFS. Verity Credit Union has contracted with CFS to make non-deposit investment products and services available to credit union members.
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An Investment Advisor registered through CUSO Financial Services, L.P., Gavin has 22 years of experience as an advisor in the Puget Sound area.
“I believe every client is unique and deserving of a personalized financial plan that will help them reach their individual financial goals. Before I make any recommendations, I like to get to know my clients. By asking the right questions, and developing an honest, trusting relationship I can really get a sense of what’s going to work best for them.”
Gavin graduated from the University of Washington with a BA in Business Administration and started his financial career with US Bank in the Investment Department. Prior to joining Verity in 2006, he spent eight years with Piper Jaffray.
So what is Gavin’s vision for his dream retirement?
“My dream retirement would be absolutely worry free: financially, emotionally, and in every aspect of life. My finances would be in order so expenses for travel, luxuries, and gifts for the kids, grandkids, and great-grandkids would be taken care of. My kids would be financially sound, so I would be confident in their prosperity. This would give me the freedom to travel and play and do whatever it is I want to do.”
When Gavin’s not working, he enjoys spending time with friends and family, watching Husky football, and taking weekend trips around the Northwest.
Gavin is registered to transact securities business in the states of WA, OR, CA, AZ, FL, HI, ID, IL, MN, NM, NY and VA.
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