The confusion between the Price paid for a stock and the Value of a stock is a common misunderstanding.
Frequently, investors are attracted to stocks trading under $1.00 per share equating the price with value. In their minds, a stock under $1.00 must be “cheap” and they must be receiving a bargain. But it is important to understand that a low stock price does not necessarily make a stock cheap. And it is crucial to understand the difference between the two terms to avoid the pitfalls of the penny stock allure.
Investors looking to make a quick buck are often seduced by stocks trading at or near penny-stock status. Attracted by the inclination that if they were to purchase a $0.20 stock, they are receiving a bargain and that the gains could far surpass the gains of larger companies. Such as Microsoft (MSFT:NASDAQ), which trades at $250, or even Alphabet (GOOGL:NASDAQ), which currently trades in the $2,400 range.
Considering how common this mistake is, it comes with no surprise that one of Warren Buffett’s most famous quotes references this exact misconception.
“Price is what you pay. Value is what you get.” – Warren Buffett
Using a simple exercise to highlight the difference between the price paid and the value received. Consider a shopper who is deciding between two separate, but similar, 2-gallon jugs of milk. The first jug of milk is $10 and does not expire for 10-days, while the second jug is only $5, but expires in just one day. Bearing in mind the price of each jug and their respective expiry dates, would the shopper be receiving better value for purchasing the $5 jug of milk?
Unless the shopper plans to consume all 2-gallons in one day (not a smart decision), the $10 jug provides better value, despite being double the price. Its utility is 10 times longer. The point is one needs to assess the value of the underlying product (or stock) before concluding that a product (or stock) is in fact “cheap”. Simply looking at the price being paid is not enough to come to this conclusion and has no place in a well-designed stock investment strategy.
Enough with the milk. Let’s look at a real-world example from KeyStone’s research.
In the spring of 2020, KeyStone recommended Alphabet Inc. (GOOGL:NASDAQ) at a price of $1,413. At that time, in our initial buy recommendation report, it was indicated that the stock was cheap in relation to its peers. At $1,413 per share, some investors automatically assume the stock to be far too “pricy”. It is not the case.
Just under one year since our initial recommendation on Alphabet and the stock trades at $2,400, returning our clients over 70%. And today, the stock continues to trade at 30 times earnings, has grown its twelve-trailing-month (TTM) revenue at 18% year-over-year, and remains relatively cheap in our view – despite trading at $2,400 per share.
There are thousands of stocks on the market trading under $1.00 that were then and continue to be today, expensive relative to the price of Alphabet. Don’t make the mistake of confusing Price paid versus Value received. It is a simple error to avoid and if recognized – it could save you from making an expensive mistake.
Of course, not all stocks trading in the under $1.00 or under $5.00 range are expensive. In fact, KeyStone’s GARP or Growth-at-a-Reasonable-Price research criteria leads us to identify which low “priced” stocks actually provide value.
Those little gems such as XPEL Inc. (XPEL: NASDAQ), Sangoma (STC: TSX), Photon Control (PHO: TSX), H20 Innovation (HEO: TSX), Boyd (BYD: TSX), and more, all low-price growth and value stocks which have produced hundreds to over thousands of percent gains for clients – you just have to know how to differentiate price with value.
