A Low Stock Price Is Neither Cheap Nor Less Valuable

I heard a comment on a New York Times Weekend Business podcast saying that a share of GM stock can’t buy a gallon of gas for a Chevy and a share of GE stock can’t buy two energy-efficient compact fluorescent bulbs (as of a week and half ago before the bounce back). While true, I don’t know those facts alone tell us anything.

Here’s a small quiz. Suppose I’m interested these three stocks:

Stock Price
Berkshire Hathaway B (BRK.B) $2,704.00
Google (GOOG) $335.34
Microsoft (MSFT) $16.90

Which stock is more expensive? Which company is more valuable?

Without looking up additional facts, I can’t answer either question. After looking up some numbers, I can answer the second question, but I still can’t answer the first one. The market capitalization (or “market cap”) numbers tell me that Microsoft is the most valuable company among the three.

Microsoft’s market capitalization is $150 billion, followed by Berkshire Hathaway’s ($128 billion), then Google’s ($106 billion). A low stock price does not mean the company is not valuable. In my example Microsoft has the lowest stock price but it has the highest value as a company. Why? Because it has more shares. A low stock price also doesn’t mean it has more room to grow. A high stock price doesn’t mean the price will have to fall. I don’t think Microsoft’s stock will go to $300 a share any time soon. Nor do I think Google’s stock will fall to $20 in the near future. Microsoft’s $16.90 stock price doesn’t tell me anything by itself. If someone says a share of Microsoft stock can’t buy a copy of Windows Vista, I really don’t know what that’s supposed to mean.

As for which stock is more expensive and which stock is cheaper, it has to do with the P/E ratio and earnings growth. I can’t figure it out. If someone knows which stock is more expensive and which stock is cheaper, please show me how you did it.

The prices for mutual fund shares are even less meaningful than the stock prices. Suppose there are two S&P 500 index funds:

Fund Net Asset Value (NAV)
Vanguard 500 Index Fund (VFINX) $72.08
Fidelity Spartan 500 Index Fund (FSMKX) $53.88

Is the Fidelity fund cheaper or better because its price per share is lower? No. It may be cheaper or better for other reasons, but not because its price per share is lower. The Net Asset Value (NAV) has nothing to do with how the funds will perform. If you put $10,000 into the Vanguard fund, you get fewer shares, but it’s still $10,000. After a year, assuming you reinvest all distributions, you will have roughly the same amount of money in either fund.

This reminds me what someone told me about how mutual funds did business in China. As in the United States, there are also open-end mutual funds in China. When a new fund goes on the market, the price always starts at ¥1 (CNY) a share. Because the stock market did well (this was a few years ago), some older funds were selling at ¥2-3 a share while newer funds were coming to the market at ¥1 a share. The newer funds were seen as being cheaper and having more room to grow because their prices were lower. The older funds were said to be too expensive because their prices had already gone up a lot. Then the older fund struck back. They split their shares and made their share price also ¥1. They ran advertising campaigns saying their shares were “on sale.” That was brilliant.

Stock prices also have to do with the stock market customs. Here in the United States we are used to having stock prices usually between $10 and $100. Once a stock goes to single digit, the company is perceived as being in trouble. In the UK, the stock prices are quoted in pence. A pence (1/100 of a British Pound) is worth about 1.4 U.S. cents now. A share of the big oil company BP is worth 459p. A share of wireless company Vodafone, which owns 45% of Verizon Wireless in the U.S., is worth 120p. By the U.S. standard, the stocks of these two companies are both in the single digit. I don’t think they are in trouble though. That’s just how things are in the UK.

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