One of the most common mistakes that people make when it comes to stock prices is that they assume that stocks with higher prices are worth more.
If stock A is priced at $40 and stock B is priced at $80, most people think that stock B is more valuable.
This is not necessarily true as the stock price has very little to do with how valuable a company is.
If a company has a higher stock price and is more valuable than a company with a lower stock price, it’s more so the case that this is just a coincidence.
For this reason, when it comes to stock market returns, it’s better to think about it in terms of a percentage, rather than in terms of the amount of money gained by a single stock.
This is exactly why you may hear on the news that a stock has increased by 10% or dropped by 25%. It’s the percentages that count and not the stock price.
The stock price of a company simply represents the value of one stock.
Different companies have a different number of stocks that have been issued. One company may have issued 10,000,000 stocks, while another company may have issued 25,000,000.
The market value of a company can be calculated by multiplying the stock price by the number of stocks that have been issued by a company.
For example, if company A issued 10,000,000 stocks and the stock price is $5, the value of the company would be $50,000,000.
This figure, the market value of the company, is known as the market capitalisation of a company.
To figure out if one company is worth more than another company, you simply need to look at the market capitalisation of each firm.
If stock A has a market capitalisation of $50,000,000 and stock B has a market capitalisation of $60,000,000, stock B is clearly more valuable.
In the last lesson, we explained that stock prices change based on country-specific, sector-specific or company specific information. This is one of the reasons why stock prices differ.
A more fundamental reason is that companies issue their stock at different prices.
One company may decide to sell their stock at $5 per stock, while another may decide to sell their stock at $10 per stock.
It only affects the value of each company if they issue different numbers of stocks.
For example, if company A issues 50,000,000 stocks at $5 and company B issues 20,000,000 stocks at $10, stock A would be more valuable. This is because $5 multiplied by 50,000,000 is $250,000,000, while $10 multiplied by 20,000,000 is just $200,000,000.
Companies may decide to price their stock at a lower price to make it more attractive to investors.
This is a good thing for investors because it allows companies to more easily increase the value of their company, while making it easy for investors to sell their stocks if they want to.
If a stock price is too high, it becomes unaffordable for some investors, who may prefer to invest their money in other stocks.
This could drive down the demand for a stock, making it go down in value. Therefore, companies sometimes decide to increase the number of available stocks to keep the price low.
One of the most common ways of doing this is by utilizing a stock split, which is where a company decides to split the number of stocks currently issued into large number of stocks.
For instance, a company may decide to give investors 2 stocks for every 1 stock in issue.
This may sound confusing but it is very simple. Investors keep the same value of their stocks, they are just split in half to create a larger number of stocks in issue. This has the effect of pushing down the stock price.
For example, if an investors own 1 stock at $5 and a company decides to do a 2-for-1 stock split, the stock price would drop to $2.50 and the investor would own 2 stocks.
Apple recently implemented a stock split of 1 stock for 4 stocks, which had the affect of driving the stock price down from around $450 per stock to around $112 per stock.
This action obviously kept Apple stock low, allowing it to remain attractive to potential investors.
Sometimes a company may deliberately decide to keep it’s stock price high. The reason they are doing this is to attract a particular type of investor.
In a lot of cases, companies with high stock prices are trying to attract loyal shareholders that believe in the vision of the company.
These types of company want a high stock price to help keep their stock price more stable, reducing the ability for investors to buy and sell stock in a short timeframe.
Warren Buffett’s Berkshire Hathaway are one of the most famous stocks that has a high stock price. Berkshire Hathaway stock A is priced at $306,202.00 per share (yes you read that correctly).
Obviously Berkshire Hathaway stock is priced higher than a lot of houses. The company have done this deliberately so that they attract investors that have really thought about their investment in the company and who are committed to see it though into the long term.
You certainly wouldn’t make a $306,202.00 investment lightly.
For a lot investors, Berkshire Hathaway stock is out of reach. Luckily though, the company have issued another type of stock (stock B), which is priced at a much more affordable $201.90.
The two stocks typically attract slightly different pools of investors, with stock B investors more likely to buy and sell more regularly. Stock A, on the other hand, is more stable as investors are less willing to sell their positions.