$3 or $30 stock

I would like to bring to light a common misconception carried by many investors. Its probably a psychology point-of-view. But I would like to clear it up today. Most people think that when they invest in a 3 dollar stock, they are conservatice and the share isn't risky at all. On contrast, when they invest in a 100 dollar stock, suddenly the stock is seen to be risky and they can't bear to see a stock plummet from 100 dollars to less than 10. Their believe is, "A $100 share is more risky than a $3 share".

That is actually wrong. Assuming both companies go bancrupt and both their shares go to zero, then a person would have lost exactly the same amount of money. The only difference is in the number of shares they hold. But their losses are exactly the same. Lets talk about volatility here for a moment. If you own 10,000 $3 shares, then if the shares move to $3.30, a 10% increase, you would have made a tidy $3000 profit. Now lets look at the $100 share. If you own 300 of those, and the share price moves up 30% to $130, you would also have made a tidy $3000 profit.

Now you might ask does shares which sell for less have a tendency to move more than shares that sell for more? So coming back to the $3 share again, in the sharemarket it is very likely that the share moves up 30 cents to $3.30 in just a matter of a few days, and yes you can make a fast profit out of shares that sell for less. However, there is also the downside that the share can move downwards by 30 cents to $2.70 and would result in a loss. Both sides are equally likely, everything else being the same.

Looking at the $100 share, it is unlikely that the share would move to $130 in the timespan of a few days. Even though the relative changes in the movements of the share price are the same(both 30%), psychology interferes and buyers aren't willing to suddenly buy the shares at $130. It is possible but might take much longer than a few days. Similarly, the likeliness of the share falling to $70 is less too. This tells us that $100 shares are actually less riskier than $3 shares. Why is that the case?

One reason is that shares which are priced at $100 are usually mature businesses that have been around for some time, who would probably have bought back shares from the market resulting in the market value per share being extremely high. The most expensive share in the world is Warren Buffett's Berkshire Hathaway company whose company share is selling for just over US$100,000 per share. It's because he has bought back many of his company shares, and the result is only few shares still circulating around in the market. On the other hand, low-priced shares are most of the time businesses that are new, fresh and ready for the market to determine its future earnings potential and hence its share price.

Depending on the type of investor you are, you might choose riskier or less riskier shares. Alternatively, you can choose not to commit yourself to either category and stick to being a dynamic investor. Usually this is the best choice. What you got to make sure is that the business is a wonderful business selling at a fair price. If you just follow this rule, you can't not succeed in investing.

I end with a quote from Robert Maple-Brown, one of Australia's masters of the market, "We are trying to find good companies that are selling at reasonable prices. That's always been our philosophy. Nothing much has changed."