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.

Treasury bill vs. mutual fund: “Instead of mutual fund, why not T-bill?”

treasury bill vs. mutual fund

Treasury bill is noted as one of the most popular investment products globally, mainly due to its simplicity and low-risk nature. However, the proliferation of mutual funds, particularly money market funds, has led to diversion of some investors from T-bills. Some questions still remain unanswered regarding Treasury bill vs. mutual fund investment. Such questions are similarly raised by well-informed investors as well as potential investors who wish to make good choices in their investment decisions.

Just about a week ago, I happened to have a discussion with one of Sikasεm’s followers. After almost an hour chat with Kenneth, he asked:

“If you were going to invest in an Mfund, why not just buy a treasury bill?”

The argument centred on the fact that managers of money market funds invest collected pool of money in fixed income securities such as T-bills. As such, won’t it be logical for investors to buy the T-bills rather? While Kenneth’s argument appears laudable, both T-bills and mutual funds have their own pros and cons that must be carefully reflected on (Note: ‘mutual fund’ as used in this write-up refers to money market funds in general).


  1. Treasury bill vs. mutual fund: Unlike T-bill, an investor can regularly top up the same mutual fund account

As it stands now, it is not allowed to top up an existing T-bill investment with additional funds. For instance, you may have invested GH¢200 in a 91-Day T-bill a month ago and wish to top up the existing GH¢200 with an additional GH¢100 to form a single investment of GH¢300. This would not be possible due to the differences in interest rates and maturity dates. In other words, the initial GH¢200 would be maturing at an earlier date with a different interest rate. As you may be aware, interest rates of T-bills keep changing week by week.

Let’s assume that the GH¢200 you invested a month ago had an interest rate of 18%, maturing on 14th April 2017. Now, interest rate of 91-Day T-bill has dropped to about 15%. Besides, any money invested in a 91-Day T-bill today would be maturing after three months. This makes it difficult to combine the subsequent GH¢100 with the GH¢200 invested earlier on. You may therefore have to invest any new fund (in this case, the GH¢100) separately. Thus, you would be having several T-bill investments for the various additional funds that would be maturing on different dates.

The situation is different for mutual fund accounts since you can top up with any amount at any time. An investor can make a regular contribution to his mutual fund account to suit his needs. A mutual fund may be therefore ideal for investors who choose to consolidate their fixed income investments in a single portfolio.


  1. Treasury bill vs. mutual fund: The yield on mutual funds general exceeds that of T-bills, even though slightly

Historically, the yield on mutual funds appears to be slightly better than that of T-bills. Detailed comparison of historical data of mutual funds and T-bills can be found in the post below:

Performance comparison of mutual funds in Ghana

There are a number of financial institutions that pay higher than the prevailing market rates. These institutions however require a minimum investment amount that outweighs the financial capability of many individual investors. As institutional investors, mutual fund managers are able to raise such minimum bids to earn the attractive rates. This is one of the reasons why mutual funds generally perform better.


  1. Treasury bill vs. mutual fund: Commissions are paid on mutual fund accounts but not on T-bills

Investing in T-bills come with no charges. Authorised dealing institutions are paid commissions by the Bank of Ghana (the originator of T-bills). Thus, the investor pays no further charges. On the other hand, mutual fund investment comes with varying fees and commissions. For details on investment fees and commissions, refer to the post below:

Investment costs in Ghana: Understanding the fees and commissions

Due to the fees and commissions charged on mutual funds, an investor may need to stay invested for a while in order to cover the charges and subsequently earn some reasonable returns. For instance, most mutual funds charge upfront fees of 1% of the invested money. Let’s assume that three investors decide to invest GH¢500 each in one of such funds. The fund manager would therefore charge each investor GH¢5 (that is 1% of GH¢500). Now, out of the three investors, one would like to withdraw his money after just a month. The other two investors decide to stay invested for one year. In effect, since each investor was equally charged GH¢5, the investor who pulls back earlier after just a month appears to be paying more in fees. In other words, he pays a fee of GH¢5 for just a month of investment while the others pay GH¢5 for the whole year.


  1. Treasury bill vs. mutual fund: T-bills are safer

As far as risk is concerned, both T-bills and mutual funds (money market funds) can be considered safe. Nevertheless, T-bills appear to be safer since they are issued by the Government. It is nearly impossible for the Government to run away with investors’ money. However, the same cannot be said of the various private financial institutions that manage the mutual funds.


  1. Treasury bill vs. mutual fund: Mutual funds may require less monitoring and tracking

Since mutual funds are constantly managed by experts, investors may not be required to keep track of matters such as changing trend of interest rates, which short-term instrument to buy, which ones are maturing, which ones must be rolled over, etc. Such monitoring and decisions are taken care of by the mutual fund managers.

T-bill investors, on the other hand, must have dedicated time to keep track of their investments and make the right buying and selling decisions. This is necessary, especially if they have different funds maturing on different dates. Even though some financial institutions send notifications to remind investors of their T-bill maturity dates, many others do not send any notification.  T-bill investors would therefore need to keep track of their investments’ maturity dates in order to give any further instructions to their banks.


  1. Treasury bill vs. mutual fund: Payments of interests on T-bills are simpler and well-defined

Since there is no maturity date for mutual funds, investors who wish to use their investment as a regular income source (eg. monthly payments) may always have to fill a withdrawal instruction form on a regular basis. This is however not the case for T-bills whereby the investor is paid the interest in his account upon maturity. T-bill investors need not to fill any additional withdrawal form unless they want to prematurely terminate their investment.

The defined interests on T-bills further make financial planning easier. Before you invest your money in a T-bill, you’re assigned a defined interest rate which does not change until the investment matures. This is beneficial for investors who want to plan ahead precisely.

The yield of mutual funds however changes in line with the prevailing interest rates of fixed income securities. If you’ve had taken a keen look at the annualised yields of mutual funds, you would realise that they fluctuate almost every day. For instance, since the beginning of this year (2017), the annualised yield of Databank Mfund has kept fluctuating between 22% and 20%. A defined annualised yield of mutual funds can only be known at the end of the financial year (31st December). Hence, investors whose planning are based on today’s rate may be slightly disappointed in the course of time.

Again, Treasury bill interests can be discounted, unlike mutual funds. What this means is that the interest calculated on T-bills can be given to investors in advance, even before their invested money matures. Discounted rates are slightly lower than the normal interest rates.


  1. Treasury bill vs. mutual fund: Mutual funds offer investors the opportunity to diversify their fixed income portfolio with smaller amounts

Proper diversification is one of the important characteristics of a prudent investment strategy. Since mutual fund managers invest across varying fixed income securities, investors, by default, have their investments diversified on their behalf. This is irrespective of the amount a mutual fund investor holds. For example, ‘investor A’ who invests GH¢100 will have the same diversification pattern as ‘investor B’ who invests GH¢500. Thus, investors with smaller amounts are equally offered the opportunity to diversify their fixed income portfolio.

On the other hand, most financial institutions demand some minimum amounts for T-bills purchase. For instance, information on Databank’s website shows that a minimum amount of GH¢500 is required for their T-bills purchase. This limitation may restrict low-income investors who wish to diversify. Let’s assume that you have GH¢500 but would like to purchase a variety of short-term securities comprising of 91-Day T-bill, 182-Day T-bill and probably a fixed deposit investment. With the minimum purchasing limit of GH¢500, your GH¢500 could only buy you a single short-term security. In effect, you may not be able to diversify as you had originally intended to.