Thursday, October 31, 2013

High-Priced or Low-Priced Stocks?

All things being equal, I prefer high-priced stocks with few exceptions. While this may run contrary to popular thinking, as a financial farmer I prefer to own fewer shares of a company I deem to be a better potential investment than many shares of a less-promising investment.

There are several advantages to owning shares of high-priced stocks, although there is one significant disadvantage; the higher the price, the more room it has to fall. I've seen this scenario play out during several sell-offs over the years, where the point drop in high-priced securities typically falls more on a percentage basis than low-priced stocks. That is a risk of high-priced stocks, there is plenty of air between the top and the ground! With that caveat though, there are several good reasons to consider purchasing high-priced stocks over low-priced stocks.

High-priced stock, by definition, is priced higher than low-priced stock, and while intrinsically this might sound ridiculous, it actually points to several operations going on outside our normal purview. Generally speaking, there are less shares of high-priced stocks (which I consider an advantage for investors, as we want to own a larger and larger piece of the pie as time goes on) and consequently when you choose to Invest Like A Farmer you are very selective when deploying your seed capital into a handful of carefully researched positions rather then just throwing seeds into the wind and hoping for a winner by chance.

High-priced stocks also play on a theme we have discussed previously, namely momentum. Another seemingly unrelated occurrence begins to happen as a stock appreciates in price; more money is drawn to it. Everyone likes a winner, and there is no truer winner than a stock that keeps a steadily increasing left to right chart. This momentum often leads to one of my favorite events; a stock split!

Although a stock split actually decreases that high-priced stock's numeric standing, it also helps prevent a chart from going exponential, releases some of the pent-up momentum by providing additional shares to fill demand, and, also by definition, increases the share count which typically increases the pool of shareholders. So even though a high-priced stock may do a 2:1 split, say from 200 to 100, it is still priced above 80% of all other securities (the average S&P 500 stock price as of this blog post is about $70/share.)

Ideally, the financial farmer uses his or her seed money to purchase several handfuls of quality seeds that eventually spawn seeds of their own, pay the farmer to own them the entire growing cycle, and wealth is compounded. A high-priced stock "helps" concentrate wealth, causing the investor to focus on several potential successful business models rather than showering the fields with dozens upon dozens of cheap seeds; we want viable crops quarter after quarter, not weeds.