A Low-Priced Stock Isn't Always a Bargain

Low priced stocks offer investors some of the best opportunities in the equities market. However, reward does not come without risk. Buying a stock purely because it's cheaper could be a mistake. It is not a mistake when you buy when the company is well capitalized. Essentially, that means the company can easily pay its debt service and does not need to issue more stock to raise money. As far as performance is concerned, the company should have clear earnings growth projections and is showing mass appeal for a product or service that can easily become a household name. Without these essential things, it is almost always better to go with a similar stock that is priced higher.

Higher volatility

Lower priced stocks means higher risk. Take for example a stock that is trading at roughly ten dollars a share and compare it to a stock that is trading at one hundred dollars a share. If there is high trading volume, the hundred dollar stock will have a bid and ask spread no more than fifty cents that equates to 0.50% of the stock price value.

Conversely, the stock trading at ten dollars per share could easily have a ten or twenty cent bid ask spread during high volume trading. That equates to 1 to 2 percent of the stock price value. As you can see, purchasing the lower price stock at the outset carries on a higher risk than the higher priced stock. That's not to mention the wild swings that occur in lower priced stocks during the day. It is a known fact that lower price equates to higher volatility. In the field of finance ,price volatility translates indirectly to risk. Additionally, these stocks tend to be newer companies with little to no positive earnings and a capital structure that inadvertently seeks to dilute the stock price. Given all that, low price stocks will carry on greater risk.

Lower volume

Because low price stocks are riskier, institutional investors; and ultimately, the larger investing public do not trade in low priced stocks. This means low average volumes for the listing. That will translate into wide bid and ask spreads as well as rough patches during trading activity. Normally, investors need a certain amount of volume to be able to trade the stock price , otherwise the impact makes trading and investing an uphill battle.

Index rules and exchange rules

If a stock were to go below twenty dollars per share, based on the market capitalization of the company listed in the major stock index, the stock could very well be relegated from the index. This means that all the supporting demand, the institutional forced buying into the index, will be vanquished with an ensuing lowering of the tide, so to speak. There is a price threshold that needs to be passed through for this to happen. An event of a relegation of the stock from the index hurts investors and the company.

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