Buying low-priced stocks: The benefits we underrate

low-priced stocks

Basically, listed companies on the stock market can be placed under two categories in terms of their share prices. On one side, there is the category of stocks that trade at comparatively high price per share. On the other side, there is another category that fairly trade at low price per share. One deliberation when it comes to stock trading is the decision on whether to purchase low-priced stocks or high-priced stocks. A few investors argue that buying low-priced stocks comes with many benefits. For instance, Warren Buffett, a veteran investor, argues that:

The key to successful investing is to buy low, [and] sell high.

Low-priced stocks may however not be necessarily cheap. In other words, it is important to look beyond the mere cheap price of a stock. This is because a number of factors can contribute to how high or low a stock price can be. For example, during stock split (when an institution decides to divide its existing shares into multiples), the price per each of the divided shares reduces by default while their values remain unchanged. When the shares of an institution become undervalued, it can also lead to a low-priced stock. Undervalued stocks are stocks that are sold at prices presumed to be below their true intrinsic value.

Due to the above contributing factors, using only the market price of a stock to determine its worth may be sometimes deceptive. In fact, some stocks may not be even worth the low price being paid for. For instance, cheap stocks that post fewer earnings may turn out to be costly if their price-to-earnings (P/E) ratio is high. Note that in general, the higher the P/E ratio, the more expensive the stock. The Ghana Stock Exchange publishes P/E ratios of the various listed stocks on its website. Recognising the underlying (or intrinsic) value of a stock when making decision on low-priced stocks would be useful.

Now, before we begin to list some of the benefits of buying low-priced stocks, we should bear in mind that buying low-priced stocks may also come with some downsides. In the meantime, let’s focus on their upsides.

 

  1. Lower initial investment

Low-priced stocks offer investors the opportunity to start with minimal amounts. This is particularly beneficial for low income earners as well as new investors who may not have that much to begin with. Besides, it makes it easier for one to invest as much of his investible money as possible. Remember that shares are bought in wholes, not in fractions. For instance, you cannot purchase 2.5 shares of a company’s stocks. Neither can you purchase 2.99 units of shares from the stock market- You are allowed to purchase in whole numbers such as 2 shares, 3 shares, etc. Let’s assume that you have only GH¢50 at your disposal to purchase some stocks on the GSE. With this amount, you can only afford one share of AGA (AngloGold Ashanti Limited) which is currently traded at GH¢37 per share. Thus, the remaining GH¢13 may be left idly. Meanwhile, the same GH¢50 could purchase 55 shares of CAL bank stocks (currently traded at GH¢0.9 per share), leaving just GH¢0.5 unused. In effect, low-priced stocks can offer maximum utilisation of one’s investment.

 

  1. High potential for growth

Low-priced stocks, in particular, undervalued stocks, appear to have greater potential for growth. In general, it is likely for the share price of a low-priced stock to rise steeply if the company comes out with something favourable. This places its shareholders in good position to make some gains. With any slightest increase in share price, investors owning more stocks stand a greater chance to increase their returns. For example, an investor with GH¢500 can purchase 10,000 shares of a stock priced at GH¢0.05 If the share price of this stock increases by 0.01 to GH¢0.06, the investor’s stock value would be GH¢600 (that is, 10000×0.06). This would be 20% appreciation from the original purchase price. In comparison, if an investor use the same GH¢500 to purchase 100 shares of a stock priced at GH¢5, he may not achieve similar results when the price of the stock appreciates by 0.01. In this instance, the value of the investor’s stocks would be GH¢501 (that is, 100×5.01), representing just a 0.2% appreciation.

It may also be important to note that not all low-priced stocks have the potential to appreciate exponentially at a given time. Moreover, the price movement of a few low-priced stocks tend to be erratic and risky. A typical example is CPC (Cocoa Processing Company) stock, known to be one of the low-priced stocks on the Ghana Stock Exchange. In fact, the share price of CPC can increase or drop by 50% within a particular trading day. Over the past five years, CPC stock (currently priced at GH¢0.02/share) has periodically enjoyed substantial [±50%] price movements within some particular years. Notwithstanding these significant movements, the opening and closing prices of CPC stock have remained unchanged in each of the individual years (since 2011). In effect, in terms of annual returns, CPC stock has recorded 0% from 2011 to 2016.



  1. The potential for high dividend earnings

Dividends are paid on each share held by a shareholder. This means that the higher the number of shares owned, the higher the earnings derived from dividends. All things being equal, as stock prices fall, they become cheaper to buy. Thus, you get the chance to buy an investment at a bargain rate. Low-priced stocks offer you the advantage of acquiring increased number of shares at the same monetary value. Let’s have a look at the example below:

Two investors, Gadasu and Ashai, both had GH¢1,000 at their disposal to purchase some stocks on the Ghana Stock Exchange. They both settled on purchasing shares of Societe Generale Ghana Limited (SOGEGH). However, Gadasu completed his purchase on 31st December 2014 while Ashai bought his shares two years later, on 30th December 2016. The price per share of SOGEGH on 31st December 2014 and 30th December 2016 was GH¢1 and GH¢0.62 respectively. Hence, with the GH¢1000, Gadasu possessed 1000 shares while Ashai owned 1612 shares of SOGEGH.

Now, in May 2017, Societe Generale paid a dividend of GH¢0.033/share to each qualified shareholder.  Gadasu and Ashai therefore earned GH¢33 and GH¢53.2 respectively from the dividend pay-outs.

It can be deduced from the above example that the low price of SOGEGH stock in 2016 gave Ashai the advantage to acquire more number of shares compared to what Gadasu attained in 2014. Ashai’s increased number of shares therefore made him earn more in dividends than Gadasu even though they equally invested GH¢1000. Unfortunately, not all companies follow a regular pattern of dividend payments. Furthermore, the dividend yield of many stocks may be considered too low. Thus, the advantage of earning more dividends from low-priced stocks may not be practical for all stocks.

 

  1. Improved diversification

Diversification continues to be a common term in the investment world due to the associated positive outcomes. Earlier in this post, it was mentioned that low-priced stocks make it affordable for investors to start with minimal amounts of money. The affordability factor allows investors to be able to invest a small amount of money in a diversified portfolio. Now, imagine a low-income earner who wish to invest GH¢50 in a diversified stock portfolio. If this investor selects Anglogold Ashanti (AGA) as one of his stock picks, he may end up spending almost all his GH¢50 on just a single share of AGA since one share of AGA is priced at about GH¢37. On the other hand, the investor may be able to purchase a mix of stocks comprising CAL bank (currently priced at about GH¢0.9), SOGEGH (currently priced at GH¢0.75) and probably GOIL (currently priced at GH¢2.29). For example, out of the GH¢50, he could spend GH¢20 on 22 CAL shares, GH¢10 on 13 shares of SOGEGH and GH¢20 on 8 shares of GOIL. This therefore gives the investor the opportunity to reap many of the benefits associated with investment diversification.

Leave a Reply