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.

4 financial stocks you may consider buying

4 financial stocks

Financial stocks generally perform well on the Ghana Stock Exchange in comparison to stocks of other sectors. Although I invest most of my stock portfolio in equity funds managed exclusively by professionals, I also enjoy picking some stocks on my own. Yeah, sometimes it’s fun to do some things on our own even though we may not be that ‘professional’. However, since stocks require some needful attention, I prefer to select very few ones which I can keep track. When it comes to stocks trading, a lot of measures need to be considered. For simplicity, I mostly look at three basic factors:

1. The price & worth of the stock.

2. How active the stock trades on the market.

3. How consistently dividends are paid by the listed company.

See also: A simple stock trading strategy for the risk-averse investor

Price & worth of stock

A huge portion of returns accrued from stocks come from capital gains. That is, the profit made by selling stocks at prices higher than what they were bought for. In other words, in an ideal condition, stocks should be sold at prices higher than what they were bought for in order to make some gains. The performance of the Ghana Stock Exchange (GSE) has been on a downward trend this year, with a year-to-date composite index of -12.11% as of 10th June, 2016. This compounds the stock market’s loss of -11.77% for the year 2015. In effect, prices of many listed stocks have drastically dropped from their previously high prices. While it may be logical to buy stocks during this period, it is also cautious to look beyond their low prices alone. Importantly, It is vital to also consider how valuable the stock is, even though the price may be low. A simple metric used to determine the value of a company’s stock is the ‘price per earning’ (P/E) ratio. P/E ratio measures a company’s current stock price relative to the company’s earnings. In essence, it can be used to decide whether the stock of a company is worth buying or not. A low P/E ratio may indicate that the company is undervalued or doing quite well relative to historical trends. In contrast, high P/E ratios normally imply overpriced stocks. It is always advisable to only compare P/E ratios of companies in the same industrial sector. This is because different ways are employed by different sector organisations to earn their money.

Stock activeness on the market

There are a few stocks on the Ghana Stock Exchange that hardly exchange hands. Most of such stocks are held for long term by institutional investors such as the Social Security and National Insurance Trust (SSNIT). Consequently, it becomes difficult to buy or sell them on the bourse. There has been an occasion when my money was locked up by a stock broker for much longer than expected due to the lack of trading activity for the stock I opted to buy. As a result, the money lost value pending the long wait for the stock purchase. I guess you already know the behaviour of our Ghanaian currency, right? It is for this reason why I now pay attention to stocks that actively trade on the market.

Consistency in dividend pay-outs

Many of us are aware that stocks are long-term investment products. But, how patiently can we wait to reap the final long-waited returns? I agree that companies must reinvest their profits in order to grow and make more returns. However, I also believe that as investors or shareholders, there should be some form of regular motivation to keep us investing in the companies. Of course, we need to stay ‘alive’ while we keep waiting for that faraway future growth. Unfortunately, not all listed companies consistently pay dividends to their shareholders. Thus, paying attention to historical trends of dividend pay-outs would be worth it when deciding on stocks to buy.

 

The 4 selected stocks

Now, imagine buying a product which sells at 30% less than its original price a few months ago. If this product is still of good quality, won’t it be worth buying more and selling them later when the price restores to the original high price or even higher? This is the primary motive behind the four picked financial stocks.

1. UT Bank Ltd. (UTB)

The current price of UTB stock is GHS 0.07 as of 10th June, 2016. About a year ago (12th June, 2015), the same stock sold for GHS 0.19, reflecting a huge loss of 61% within the same period. The current P/E ratio of UTB is 3.5 which appears to be relatively low. As an additional background, the initial public offer (IPO) of UTB was sold in 2009 at GHS 0.3/share. The stock struggled for a while but managed to reach as high as GHS 0.52 on 10th June, 2013. Concerning its activeness on the bourse, UTB is one of a few stocks that regularly trade in high volumes. The bank has however been facing some challenges in the past years making it difficult to pay dividends to its shareholders. The last time dividend was paid was 2012, with a dividend yield of 5.26%.

 

UT bank performance chart- financial stocks
One-year performance chart of UT Bank

 

2. Ghana Commercial Bank Ltd. (GCB)

The current price of GCB stock is GHS 3.04 as of 10th June, 2016. The same stock sold for GHS 4.9 a year ago (10th June, 2015), reflecting a loss of 38% within that period. Continue reading “4 financial stocks you may consider buying”